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CBA EXAMINATION REVIEW
Business Law Certiﬁed Bank Auditor Program
Certiﬁed Bank Auditor Examination Review — Volume 7
For more than 75 years, BAI has focused on partnering with ﬁnancial services companies to improve their performance through strategic research and information, education and training delivery—all designed to help our clients leverage their most important asset—human capital. Today BAI provides a comprehensive range of end-to-end employee development solutions designed speciﬁcally to meet the needs of ﬁnancial services companies. BAI oﬀers a wide range of options for companies, including employee surveys, sales assessments, open enrollment conferences and seminars, graduate schools and certiﬁcation programs; as well as targeted learning and performance solutions. These learning solutions include a variety of e-learning courses, instructorled workshops, independent study programs and customized seminars and for all employee levels and functional areas within a ﬁnancial services company. In addition to providing timetested training content and implementation assistance, BAI oﬀers Aspen, a best-of-class learning management system to help companies track and manage the their employee development initiatives. We believe one of the keys to our success is our unique ability to fully understand an organization’s business challenges, speciﬁc employee development needs and goals so that we will be able to recommend the appropriate solution(s) to ensure achievement of client business objectives. It is our goal to focus on working in partnership with our clients to ensure successful design and implementation of employee development initiatives. We continually strive to improve our solutions and processes in an eﬀort to help our clients realize their business objectives and to get a return on their investment.
BAI would like to thank the following contributing authors, whose commitment and expertise made the ﬁ�h edition of the CBA Examination Review possible. Leo Clarke is Counsel to Watkins & Eager in Jackson, MS. He has over 25 years experience practicing and teaching commercial, corporate, banking and insurance law. He is a member of the California, District of Columbia and Washington Bars and has taught law at Ave Maria School of Law, the University of Dayton, the University of Washington and the University of Mississippi. He has published scholarly and practical articles on those topics. He is an honors graduate of UCLA School of Law and Stanford University. Rob McDonough, CRP, CIDA is the President and CEO of Strategic Financial Solutions, Inc. a ﬁnancial services consultancy. Mr. McDouough also serves as an Executive Director of the Global Financial Markets Institute, Inc., which specializes in capital markets, derivatives and risk management consulting and training. Rob has an MBA in Finance and Economics from Georgia State University and a BBA from Emory University in general business administration with a concentration in marketing. Paul J. Sanchez, CPA, CBA, CFSA conducts a CPA practice in Port Washington, New York. He is also the owner of Professional Service Associates, a consulting and professional training and development business servicing corporate clients (auditors, controllers etc.), CPA ﬁrms and others. He is an owner and auditing and ﬁnancial accounting seminar leader for the Person/Wolinsky CPA Review Courses, a company that prepares candidates to pass the Uniform CPA Examination. Mollie Newsome Sudhoﬀ, CRCM, CRP is the President of Jeﬀerson Cook Associates, Ltd. and Senior Advisor, Manager Engagements Paragon Compliance Group Winnetka, Illinois. Ms. Sudhoﬀ holds a BBA from Emory University, Atlanta, GA and an MBA from Lake Forest Graduate School of Management, Lake Forest, IL. Mollie directed the Compliance Program for BAI for several years before forming Jeﬀerson Cook Associates, Ltd. (JCA). JCA is a bank regulatory complianceconsulting ﬁrm providing compliance review and executive search services. JCA is also a partner
in Paragon Compliance Group (Paragon). Paragon is a premier provider of compliance training nationwide.
BAI has maintained a strong commitment to serving the audit community. Since BAI’s founding in 1924, quality service to auditors and a dedication to enhance internal auditing practices, through highly relevant audit research, professional development programs and technical publications, has been one of our primary missions. The corner-stone of this commitment to excellence in bank auditing is the Certiﬁed Bank Auditor (CBA Program). The Certiﬁed Bank Auditor Program was established by BAI in 1967 in order to recognize those audit professionals who excel in their ﬁeld. The CBA Program serves as a commitment to the banking industry, and to the public, that the profession of bank internal auditing is characterized as possessing the utmost in professional qualities. The philosophy of the CBA program is to provide a plateau beyond the basics of internal auditing knowledge, prepare the candidate to meet future challenges, and to raise the professional status of bank internal auditing. Today, more than 5,000 individuals have earned the right to use the CBA designation a�er their name by demonstrating, their knowledge of bank accounting, auditing principles and practices, bank regulations, economics, management and commercial law. The CBA designation is earned by passing a rigorous examination in each of the aforementioned areas. The program gives special recognition to people who by demonstrating proﬁciency in prescribed standards of performance and knowledge, have demonstrated a high level of competence and ethics. This reference document has been prepared to assist and prepare the candidate to take the CBA examination. This is the ﬁ�h edition of the CBA examination study manual, and it has been signiﬁcantly revised to reﬂect current and progressive audit skill sets.
The purpose of the CBA Examination Review is to assist candidates in preparing for the Certiﬁed Bank Auditor (CBA) professional examination by providing complete coverage of the subject ma�er. The ﬁ�h edition is a major enhancement from the previous editions. All material was expanded signiﬁcantly so that a single-source of comprehensive review materials is provided to the candidate. This makes the candidate’s preparation time more eﬀective and eﬃcient. These references are comprehensive. However, the candidate is advised to supplement these references with other reading materials as needed. The organization of this reference material parallels the common body of knowledge, which was developed for the Certiﬁed Bank Auditor Program by BAI. The examination references are divided into nine volumes:
A) Subject: Accounting Volume 2: Managerial Accounting (Part I.Certiﬁed Bank Auditor Examination Review — Volume 7 Volume 1: Financial Accounting (Part I. B) Subject: Accounting Volume 3: Auditing Principles (Part II. A) Subject: General Business Volume 8: Economics (Part IV. A) Subject: Auditing Principles and Bank Regulations Volume 4: Bank Laws and Regulations (Part II. c. THE EXAM CBA is the acronym for the Certiﬁed Bank Auditor Program. The examination and review guides are organized in the same manner as the common body of knowledge to provide an organized study program. Ability to make sound decisions. and it is currently administered at nearly one hundred domestic and international testing sites. The common body of knowledge is an outline of primary skills and knowledge needed by industry professionals to be judged technically proﬁcient as a bank auditor. and the current format of the CBA exam is entirely multiple-choice questions. B) Subject: Auditing Practices Volume 7: Business Law (Part IV. Each section contains subheadings. Application of technical knowledge. A) Subject: Auditing Practices Volume 6: Auditing Speciﬁc Bank Applications (Part III. BAI has the responsibility to ensure the common body of knowledge is reﬂective of the current state of internal auditing within ﬁnancial institutions. The CBA exam is designed to measure and evaluate basic technical competence of banking and internal audit practices and procedures. iv . Candidates are allowed three-hours to complete each part. The common body of knowledge is referenced in all BAI examination materials.Understanding of professional responsibilities. Questions which appear on the CBA examination test the material contained in the common body of knowledge on page vii. and the subject ma�er is given an overall level of diﬃculty. b. given on two consecutive days. C) Subject: General Business General Comments on the Examination I. The CBA designation is internationally recognized. B) Subject: Auditing Principles and Bank Regulations Volume 5: General Audit Practices (Part III. in June and November of each year. including: a. B) Subject: General Business Volume 9: Management Issues (Part IV. The present examination consists of four parts.
It is recommended that candidates discuss questions. each volume contains an extensive cross-referenced glossary. review the complexity and brevity of the subject ma�er so that you can determine your study needs and plan accordingly. First decide which parts of the exam that you wish to take. Additionally. These features allow the candidate to easily move throughout the text. Statistics indicate that candidates sit for an average of two parts. and study with associates and other CBA candidates in organized study groups whenever possible. This contents page directly corresponds to the respective portion of the common body of knowledge for which it represents. When you receive the materials. A STUDY PLAN Develop an overall study plan. At the beginning of each chapter of the review texts is a self contained table of contents.Introduction II. v . Allow suﬃcient time for processing and shipping your examination review orders. However. candidates will ﬁnd an acronyms and abbreviations section. The review material was designed and developed using the CBA common body of knowledge as the frame work. and concentrate on the sections that pertain to their weak exam points. This style is used to make the material easier to read. the trend recently has been for candidates to take all four parts in their ﬁrst si�ing. In general. In the back of each of the volumes. as well as all pertinent reference information. The text makes extensive use of shaded boxes and bullet points. EXAMINATION REVIEW MATERIALS The examination review manuals were constructed using an exhaustive and detailed analysis of the new CBA common body of knowledge. Statistics indicate candidates have more success when preparing with study partners or groups. III. The third step is to prepare a time schedule for your self-study program. The objective of this plan will be to master the common body of knowledge. It is recommended that you develop a schedule of self-study sessions that systematically covers the topics. The material is presented in nine comprehensive well cross-referenced volumes. and to highlight key items throughout the reference. The overriding consideration was to provide comprehensive. The second step is to gather the necessary study materials. eﬀective and easy-to-use examination review guides. candidates who believe they have the necessary knowledge and experience are encouraged to take all four parts at their ﬁrst si�ing.
Generally Accepted Accounting Principles 2. Management of the Internal Audit Department f. Financial Services Instruments and Products Part II: Auditing Principles and Bank Laws A. Financial Statement Presentation b. CBA Code of Ethics 2. Accounting Principles a. Cost/Beneﬁt of Controls e. Evaluation of Internal Control Structure a. Net present value & internal rate of return 2. Managerial Accounting (10–20%) 1. Responsibility b. Responsibility for Internal Control c. Information Systems Processing vi . Comparative Statements c. Cost-Volume Relationships a. Cost Accounting 3. Financial Accounting (80–90%) 1. Bank Accounting a. Capital budgeting & income taxes c. Proﬁt/expense centers c. Conceptual Framework b. Audit Trails d. Budgets and Responsibility Reporting a. Financial Statements a. Compliance with Policies and Procedures d.Certiﬁed Bank Auditor Examination Review — Volume 7 COMMON BODY OF KNOWLEDGE Part I: Accounting A. Capital Investment Decisions a. Controllable and uncontrollable costs d. Reporting Standards 3. Independence b. Break-even analysis c. Uses of Financial Statements B. Auditing Principles (50–60%) 1. Internal Control Structure a. Segregation of Duties and Dual Control c. Scope of Work d. Purpose of Internal Controls b. Types of budgets b. Professional Proﬁciency c. Performance of Audit Work e. Organizational/Departmental Structure 3. Standards for the Profession of Internal Auditing a. Contribution analysis b. Speciﬁc Accounting Treatment c. Cash inﬂows/outﬂows b. Cost-beneﬁt analysis 4. Ratio Analysis b.
Borrowing by Depository Institutions—Reg A b. Managing the Audit Department c. Independence and Objectivity 6. Real Estate Se�lement Procedures Act d. Overview of the Regulatory Environment a. Audit Commi�ee 5. Flowcharting f. Federal Reserve System b. Truth in Lending—Reg Z b.Introduction 4. Work Programs/Questionnaires g. Interest on Deposits—Reg Q vii . Statistical Sampling c. Bank Organization a. FDIC d. Fair Credit Reporting Act e. Audit Evidence k. Consumer Protection a. Fair Housing Act c. Use of Microcomputers i. Fair Debt Collection Practices Act f. Internal Audit’s Relationship with the External Auditors a. Oﬃce of the Comptroller of the Currency c. Home Mortgage Disclosure Act—Reg C b. Workpapers—Preparation and Review b. Compliance and Substantive Testing B. Bank Holding Company Act—Reg Y b. Bank Laws and Regulations (40–50%) 1. Other Real Estate Owned 4. Electronic Funds Transfer Act—Reg E d. Reserve Requirements—Reg D c. Mortgage Lending a. Auditor Training d. Community Reinvestment Act—Reg BB g. Conﬁrmations d. Communications with Management. Audit So�ware e. State Regulatory Systems e. AICPA Statements on Auditing Standards (SAS) b. Audit Techniques a. Objectives. Equal Credit Opportunity Act—Reg B c. Responsibility and Authority c. Integrated Audits h. Monetary Policy a. Management and Organization of the Audit Function a. Analytical Review j. Audit Department Charter b. Directors and Others e. Other 2. Transactions with Aﬃliates—FRB Sections 23 A&B 5. Consumer Leasing 3.
Recovery and Enforcement Act (FIRREA) c. Miscellaneous Part III: Auditing Practices A. Bank Operations a. Auditor’s Use of Microcomputers g. Segregation of Duties d. Maintenance of a Key Indicator Program viii . Development of Audit Work Papers d. Audit Planning and Preliminary Surveys b. Report of Findings f. Bank Protection Act � Reg P b. Statistical Sampling b. Board of Directors/Audit Commi�ee b. Other a. General Practices (20–40%) 1. Input/Processing/Output Controls c. Audit Process a. External Auditors and Regulators c. Bank Bribery Act d. Risk Analysis h.Including Microcomputers j. Flowcharting f. Bank Secrecy Act f. Authorization of Transactions h. and Others a. FDIC Bank Improvement Act of 1991 f. Availability of Funds and Collection of Checks � Reg CC 7. Analytical Review e. Separation of Processing and Development e. Internal Control Development b. Depository Institution Management Interlocks Act � Reg L d. Maintenance of Continuing/Permanent Work Papers and Files g. End-User Computing . Conﬁrmations c. Financial Institution Reform. Development of Audit Work Programs c. Contingency Planning 3. Audit So�ware d. Application of Audit Techniques a. Loans to Executive Oﬃcers � Reg O e. Control of Data Files g. Communications with Management. Auditee/Client 4. Foreign Corrupt Practices Act g. Computer Assisted Audit Techniques 2. Trust � 12 CFR Part 9 e. Physical and Data Security Access Control i. Edge Act � Reg K c. Evaluating the Internal Control Structure a. Collection of Checks and other Items � Reg J i. Review and Evaluation of Findings e. Reconciliation of Input to Output f. Directors.Certiﬁed Bank Auditor Examination Review — Volume 7 6. Tax Equity and Federal Responsibility Act (TEFRA) b. Credit by Banks for Purchase of Margin Stocks � Reg U h.
Investment Securities and other Investment Vehicles f. Article 4 � Bank Deposits and Collections e. Article 1 � General Provisions b. Capital Accounts & Dividends 3. Liabilities and Owners Equity a. Checking Accounts b. Estates and Trusts b. Commercial Loans/Leases g. Article 9 � Secured Transactions 2. Agency f. Funds Transfer c. Article 8 � Investment Securities g. Wills. Article 3 � Commercial Paper d. Assets/Income a. Proof & Transit c. Dra�s. Antitrust ix . Collections d. and Audit Procedures 1. Bankruptcy h. Contracts g. Oﬀ-Balance Sheet Items k. Due from and Due to Banks e. Interoﬃce Accounts d. Installment Loans i. Savings Bonds h. Fixed Assets and Depreciation/Other Real Estate Owned 2. Partnerships e. Insurance c. Customer Securities Safekeeping j. Loan Interest and Fee Income j. Night Depository f. Cash and Cash Items b. Savings Deposits d. Safe Deposit e. Allowance for Loan-losses and Charged oﬀ Loans k. General Commercial Law a. Auditing Speciﬁc Bank Applications (60–80%) Risks/Exposures. Trust l. Guaranty and Suretyship d. Article 2 � Sales c. Money Orders. Other Services a. and Oﬃcial Checks c. Article 5 � Le�ers of Credit f. Payroll and Employee Beneﬁts b. Business Law (30 . Time Deposits e. Control and Audit Objectives. Travelers Checks g. Real Estate Mortgage and Construction Loans h. Customer Repurchase and Reverse Repurchase Agreements i. Credit Cards Part IV: General Business A.Introduction B.40%) 1. Uniform Commercial Code a.
Macroeconomics a. Role of Interest Rates d. Growth and Inﬂation c. Competitive Strategies 1) Products 2) Marketing 3) Customers c. Economic Indicators 3. Bank Management a. Economics (15–25%) 1. Management Issues (25 . Fiscal Policies and Theories 2. Forecasting a. Short-term Savings and Debt Instruments e. Money Markets a. Planning 1) Policies and Strategies 2) Budgets and Standards e. Business Cycles c. Role of Money and Commercial Banks b. Business Conditions and Trends b. Asset/Liability Management 1) Sources 2) Products 3) Matching of products for funding needs b. Economic System b. Communicating with Management 1) Wri�en 2) Oral x . Bond and Stock Markets C.Certiﬁed Bank Auditor Examination Review — Volume 7 B.35%) 1. Human Resources/Personnel 1) Training and development 2) Recruiting 3) Ethics d. Business Cycles. Organizing 1) Theories of Management 2) Methods f. Monetary Management Theories c.
gov Auditing • American Institute of CPAs www. Accounting • Financial Accounting Standards Board www. BAI strongly recommends referring to the following web sites in order to obtain the most up-to-date information and materials pertaining to Statement of Financial Accounting Standards.pcaobus. GAAP statements and FASB statements and other supplemental study materials. Important Note The material in this publication was believed to be accurate at the time it was wri�en. candidates are tested on their knowledge of the audit process and the auditor’s relationship with internal and external sources.org • U. Due to the evolving nature of laws and regulations within the Auditing ﬁeld. This part of the examination complements Part 2 of the exam (Auditing Principles) in that it tests candidates on their application of audit knowledge.aicpa. Securities and Exchange Commission www.org • U.S. The Auditing Practices skill set constitutes the entire Part 3 of the CBA examination. Consequently. It is recommended that these parts be studied together. Securities and Exchange Commission www.org/ct) • American Institute of CPAs www.org • The Institute of Internal Auditors www.sec.theiia. A) T he profession of bank internal auditing is a dynamic and creative enterprise. Additionally. Professionals in this ﬁeld must demonstrate considerable intellectual ﬂexibility to remain eﬀective in the constantly changing banking industry. The regulations and standards are continuously being updated and amended.fasb.gov • Public Company Accounting Oversight Board www.org (www.org xi . This reference manual is organized to directly correspond to the common body of knowledge as well as to past examinations. because they are so closely linked.fasb. BAI makes no guarantees as to the accuracy or completeness of the information contained in this publication. Parts 2 and 3 have been included in this volume of the review manuals. Therefore. rather than the mere concepts.sec.aicpa.S. This part tests a candidate’s knowledge of the application of audit techniques as well as the review and audit of both automated and manual systems of internal control.Introduction Volume 7: Introduction Business Law (Part IV.
6 1.3 1. which makes up 30 to 40% of Part 4 of the CBA exam.5 1. which makes up 25 to 35% of Part 4 of the CBA exam Chapter Topics The following topics are addressed in this chapter: 1.Sales Article 3 .Le�ers of credit Article 8 .Investment securities Article 9 . Volume 9 addresses Management Issues. Volume 8 makes up Economics.Commercial paper Article 4 .General provisions Article 2 .Bank deposits and collections Article 5 . you will be able to: • explain the general purpose of the Uniform Commercial Code (UCC) • describe many of the integral deﬁnitions contained in Article 1 of the UCC • explain the essential elements for a sales contract • describe the rules for passage of title • explain the methods and eﬀects of acceptance and rejection of goods in a sale • describe the diﬀerent warranties • identify the ways in which a contract may be breached and remedies available • name the diﬀerent types of commercial paper and roles/responsibilities of parties • list the requirements for negotiability of an instrument and characteristics of non-negotiable instruments • summarize the rules regarding endorsements • explain the concept of holder in the due course • explain the bank and customer relationship • describe responsibilities/ liabilities of banks and collection processes • explain usage of le�ers of credit and distinguish between diﬀerent types • summarize the obligations of an issuer of a le�er of credit • describe an issuer's lien and liabilities with regard to investment securities • explain the general rules in regard to terms of securities • summarize purchaser liability rules 1 .4 1.2 1.Chapter One — Uniform Commercial Code Chapter One Uniform Commercial Code Scope: Volume 7 constitutes Business Law.7 Article 1 . which make up 15 to 25% of Part 4 of the CBA exam.Secured transactions Chapter Objectives A�er completing this chapter.1 1.
principal and agent. and words of the neuter gender may refer to any gender. These principles include the law merchant and the law relative to the capacity to contract. usage. duress. misrepresentation. actions (with regard to a judicial proceeding)—Actions include recoupment. For example. Purpose of Article 1 • Simpliﬁes and clariﬁes the law governing commercial transactions. • Permits the expansion of commercial transactions through custom. fraud. The code is supplemented by the principles of law and equity.1: ARTICLE L—GENERAL PROVISIONS Purpose of the Uniform Commercial Code The Uniform Commercial Code (UCC) has been the most important business development in unifying state legislation with regard to commercial transactions. diligence. Pennsylvania enacted the Code in 1952. setoﬀ. duties and remedies of parties to a secured transaction • explain the ability of parties to dispose of collateral property a�er default • distinguish between the diﬀerent types of collateral SECTION 1. and words in the plural include the singular. and any other proceedings in which rights are determined. The purpose of the code was to collect all aspects of these transactions into one body of law. The provisions of the code may be changed by agreement among the parties except when speciﬁcally forbidden by it. or any other validating or invalidating cause. coercion. reasonableness and care may not be disclaimed. and over the next few years it was enacted by every state and territory except Louisiana and Puerto Rico. Article 1 (and General) Deﬁnitions 1. The code was dra�ed by the Commissioners on Uniform State Laws during the 1940s. estoppel. 2 . • Makes the law uniform throughout the states and territories. unless these principles are in contradiction to it. and agreement of the parties. It should also be remembered that in the code. mistake. bankruptcy. Also. words of the masculine gender include the feminine and neuter. extreme care should be taken when awarding consequential\special or penal damages except as speciﬁcally provided in the code.Certiﬁed Bank Auditor Examination Review — Volume 7 • explain the concept of a secured transaction • identify the circumstances in which security interests a�ach • summarize the methods and importance of perfection • describe the function of a ﬁnancing statement • identify the rights. words in the singular include the plural. good faith. It governs the sale of goods (tangible personal property). The remedies of the code are to be liberally administered so that the aggrieved party may be put in as good a position as if the other party had fully performed. However. suit in equity. counterclaim.
if applicable. defendant—A defendant includes a person in the position of defendant in a counterclaim. Otherwise. agreement—The bargain of the parties in fact as found in their language or inferred from other circumstances. 13. 3 . including an assignee for the beneﬁt of creditors. 14. 7. by exchange of other property. branch—includes a separately incorporated foreign branch of a bank 8. A person buys in the ordinary course if the sale to the person comports with the usual or customary practices in the kind of business in which the seller is engaged or with the seller’s own usual or customary practices. It also does not include security for—or total or partial satisfaction of—a money debt. credit union and trust company. bearer—The person in possession of a negotiable instrument. bill of lading—A document evidencing the receipt of goods for shipment issued by a person engaged in the business of transporting or forwarding goods. displayed or presented conspicuously. 6. a secured creditor. A term or clause may be made conspicuous by printing a heading in capital le�ers or. buys in ordinary course from a person in the business of selling goods of that kind. i. 9. a lien creditor and any representative of creditors. Only a buyer that takes possession of the goods or has a right to recover the goods from the seller under Article 2 of the UCC may be a buyer in the ordinary course of business. by printing that language in a larger or contrasting type or color. 12. or on secured or unsecured credit and may include receiving goods or documents of title under a preexisting contract for sale. a receiver in equity and an executor or administrator of an insolvent debtor’s or assignor’s estate. aggrieved party—A party entitled to pursue a remedy. Buying may be for cash.. creditor—A creditor includes a general creditor. family or household purposes. consumer—An individual who enters into a transaction primarily for personal. 5. (Whether an agreement has legal consequences is determined by the code provisions. conspicuous—A term or clause wri�en. This does not include a transfer in bulk. 3. in the body. including course of dealing. bank—Any person engaged in the business of banking including a savings bank. contract—The total legal obligation which results from the parties’ agreement as determined by the code and supplemented by other applicable laws.e. it is determined by the law of contracts. 11. a trustee in bankruptcy. Courts decide whether a term or clause is conspicuous or not. in such a manner that a reasonable person against whom it is to operate ought to notice it. 10. usage of trade. burden of establishing a fact—The task of convincing the triers of the fact that the existence of the fact is more probable than its non-existence. or security payable to the “bearer” or the “endorsed in” blank.) 4.Chapter One — Uniform Commercial Code 2. buyer in ordinary course of business—A person. or course of performance. who in good faith and without knowledge that the sale to him is in violation of the ownership rights or security interest of a third party in the goods. document of title. cross-claim or third-party claim. savings and loan association.
holder—The holder is a person in possession of a negotiable instrument that is payable either to the bearer or to an identiﬁed person that is the person in possession. genuine—Something is genuine if it is free of forgery or counterfeiting. 26. estate. warehouse receipts or orders for the delivery of goods. insolvent—A person who has ceased to pay his debts in the ordinary course of business (other than as a result of a bona ﬁde dispute). hold and dispose of the documents and the goods they cover. 4 . wrongful act or omission. money—A medium of exchange currently authorized or adopted by a domestic or foreign government. government. insolvency proceedings—Insolvency proceedings include any assignment for the beneﬁt of creditors or other proceedings intended to liquidate or rehabilitate the estate of the individuals involved. limited liability company. partnership. 19. fault—A fault is a default. corporation. discounted to the date certain by use of either an interest rate speciﬁed by the parties—if that rate is not manifestly unreasonable at the time the transaction is entered into—or a commercially reasonable rate that takes into account the facts and circumstances present at the time the of the transaction.Certiﬁed Bank Auditor Examination Review — Volume 7 15. 23. public corporation. document of title—Documents of title include bills of lading. or who is insolvent within the meaning of the federal bankruptcy law. the equivalent of any other like unit including goods that by agreement are treated as equivalent. The person in possession of a document of title may also be a holder. 22. They also include any other documents which in the regular course of business or ﬁnancing are treated as adequately evidencing that the person in possession of them is entitled to receive. governmental subdivision. cha�el paper or securities. breach. if the goods are deliverable either to the bearer or to the order of the person in possession. 17. an organization is deﬁned as a person other than an individual. 24. 27. fungible goods—Goods of which any unit is. business trust. delivery—The voluntary transfer of possession of instruments. organization—In the code. by nature or usage of trade. person—In the code. A document of title must profess to be issued by or addressed to a bailee. 25. 28. It must also profess to cover goods in the bailee’s possession which are either identiﬁed or are fungible portions of an identiﬁed mass. or any legal or commercial entity. a person is an individual. present value—The amount as of a date certain of one or more sums payable in the future. This includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more countries. association. or who cannot pay his debts as they become due. trust. joint venture. 18. documents of title. 16. agency or instrumentality. party (as distinguished from third party)—A party is a person that has engaged in a transaction or made an agreement subject to the code. good faith—Good faith is honesty in fact and the observance of reasonable commercial standards of fair dealing. 20. dock receipts. 21. dock warrants.
the United States Virgin Islands. record—A record is information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form. 38. representative—A representative is a person empowered to act for another including an agent. Security interest does not include the special property interest (see deﬁnition below) of a buyer of goods upon identifying those goods in accordance with Article 2 of the code. or any territory or insular possession subject to the jurisdiction of the United States. an oﬃcer of a corporation or association. properly addressed means to an address speciﬁed thereon or otherwise agreed upon.Chapter One — Uniform Commercial Code 29. Whether a transaction in the form of a lease is intended as security is to be determined by the facts of each case and is governed by explicit Article 1 provisions. 32. remedy—A remedy is any remedial right to which an aggrieved party is entitled with or without resort to a tribunal. For example. If neither of those apply the instrument may be to any address reasonable under the circumstances. This includes a forged signature. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer is limited to a reservation of a security interest. 40. and a trustee. mortgage. cha�el paper. issue or reissue. This includes any interest of a consignor and a buyer of accounts. However. right—A right is the same as a remedy. In the case of an instrument. 30. gi� or any other voluntary transaction which creates an interest in property. 39. security interest. the right of a seller or lessor of goods to retain or acquire possession of the goods is not a security interest. term—A term is the portion of an agreement which relates to a particular ma�er. 35. Yet. a seller or lessor may also acquire a security interest by complying with Article 9. signed—Something is signed if it uses any symbol executed or adopted by a party with present intention to authenticate a writing. Puerto Rico. security interest—Security interest is an interest in personal property or ﬁxtures which secures the payment or the performance of an obligation. discount. send—In this case to send is meant in connection with a properly addressed writing. implied or apparent authority. under Article 2 or 2A. 37. 31. The receipt of any writing or notice within the time it would have arrived if properly sent has the eﬀect of a proper sending. reservation of title thereunder is not a security interest. (except where a seller has shipped under reservation). pledge. 34. 5 . lease. negotiation. purchaser—A purchaser is a person that takes by purchase. purchase—To purchase is to take by sale. 41. 33. or a promissory note in a transaction that is subject to Article 9. a payment intangible. the District of Columbia. Unless a lease or consignment is intended as security. lien. executor or administrator of an estate. surety—A surety is a guarantor or other secondary obligor. record or notice which is deposited in the mail or delivered for transmission by any of the usual means of communication and with postage or cost of transmission provided. 36. unauthorized signature—A signature is unauthorized if it is made without actual. state—A state means a state of the United States. the buyer may acquire a security interest by complying with Article 9.
An organization exercises due diligence if it maintains reasonable routines for communicating signiﬁcant information to the person conducting the transaction and there is reasonable compliance with the routines. or the individual has reason to know both of the transaction itself and that the transaction would be materially aﬀected by the information. a person has notice of a fact if (1) they have actual knowledge of it. knowledge—Knowledge in the code means actual knowledge. the code indicates that notice. 48. refer to knowledge rather than reason to know. notice—Under the code. 47. course of dealing—Like a usage of trade. vocation or trade as to justify an expectation that it will apply to the transaction in question. 45. A reasonable time depends on the nature. Every contract or duty within the code establishes an obligation of good faith in its performance or enforcement. 43. purpose and circumstances of an action. The word ‘wri�en’ has a corresponding meaning. any time which is not manifestly unreasonable may be ﬁxed by agreement. writing—Writing is printing. warehouse receipt—A warehouse receipt is a receipt issued by a person engaged in the business of storing goods for hire. a course of dealing in a previous transaction between parties establishes a common basis of understanding for interpreting their 6 . whether or not the other person actually comes to know of it. the court will interpret the writing. usage of trade—A usage of trade is a practice or method used with such regularity in a place. knowledge or a notice or notiﬁcation received by an organization is eﬀective for a particular transaction from the time it is brought to the a�ention of the individual conducting that transaction or from the time it would have been brought to the individual’s a�ention if the organization had exercised due diligence. A person receives a notice or notiﬁcation when it either comes to that person’s a�ention. typewriting or any other intentional reduction to tangible form.. etc. Qualifying the above language about notice. 46. (2) they have received a notice or notiﬁcation of it. If no time is agreed upon. If such a usage is embodied in a wri�en trade code or similar writing. 44. reasonable time—When the code requires an action to be taken within a reasonable time. or it is duly delivered (in a form reasonable under the circumstances) to the place of business through which the contract was made (or to another location held out by that person as the place for receipt of such communications). pursuant to Section 1-301 of the code: Any document authorized or required by the contract to be issued by a third party shall be prima facie evidence of its own authenticity and genuineness and of the facts stated in the document by the third party. Due diligence does not require an individual acting for the organization to communicate information unless the communication is part of the individual’s regular duties. or (3) from all the facts and circumstances known to the person at the time in question. he or she has reason to know that it exists. Under the code words like discover. learn. The existence and scope of such a usage are to be proved as facts. An action is taken reasonably when it is taken at—or within—the time agreed. it is within a reasonable time. and knows has a corresponding meaning. A person notiﬁes or gives notice or notiﬁcation to another person by taking such steps as may be reasonably required in order to inform the other person in ordinary course.Certiﬁed Bank Auditor Examination Review — Volume 7 42.
(See deﬁnitions below). The express terms of an agreement and an applicable course of dealing or usage of trade should be interpreted wherever reasonable as consistent with each other. However. contract rights and accounts receivable are not considered goods. must reasonably identify the subject ma�er and must be signed by the party against whom enforcement is sought or by his authorized agent. Although these deﬁnitions apply to other articles. express terms control both the course of dealing and usage of trade. 7 . A clause in a contract that allows one party in interest to accelerate payment or performance or to require collateral or additional collateral “at will” or “when he deems himself insecure” means that he shall have power to do so only if he—in good faith— believes that the prospect of payment or performance is impaired. Article 2 Deﬁnitions Article 2 has some speciﬁc deﬁnitions that are particularly relevant to the subject ma�er contained in that article.000 in amount or value of remedy unless there is some writing. They also include the unborn young of animals.2: ARTICLE 2—SALES Purpose of Article 2 Article 2 of the UCC deals with contracts for the sale of goods.Chapter One — Uniform Commercial Code expressions and other conduct. It is important to remember that much of Article 2 may be varied by agreement of the parties and is supplemented by course of dealing and usage of trade. growing crops and standing timber to be cut. Money. it should be remembered that a course of dealing controls usage of trade. or (4) in return for any consideration suﬃcient to support a simple contract. they are most appropriately listed in Article 2. 48. A contract for the sale of personal property is not enforceable by action or defense beyond $5. The party against whom the power is exercised has the burden of establishing lack of good faith. This does not apply to contracts for the sale of goods. a person gives value for rights if the person acquires them (1) in return for a binding commitment to extend credit or for the extension of immediately available credit (whether or not drawn upon and whether or not a charge-back is provided for in the event of diﬃculties in collection). securities or security agreements. This wri�en information must indicate that a contract for sale has been executed between the parties at a deﬁned or stated price. Things a�ached to realty such as minerals or buildings are considered to be goods if they are to be severed from the land by the seller. intangible property. • goods—Goods include all items which are moveable and personal property of a tangible. physical nature. Where they are not consistent. value—Except as provided in other portions of the code. investment securities. SECTION 1. (3) by accepting delivery under a preexisting contract for purchase. in addition to the deﬁnitions contained in Article 1 that have general applicability. (2) as security for (or in total or partial satisfaction of) a preexisting claim. A course of dealing between parties and any usage of trade give particular meaning to and supplement or qualify the terms of an agreement.
• returned goods—The buyer may have the privilege of returning the goods delivered to him. the transaction is called a sale on approval. price—If a price is omi�ed. This distinction is important. then delay in performance is a material breach. usage of trade and course of performance. the contract can override the applicable code section(s) with a few exceptions. 3. price. stolen. The seller tenders the goods. payment. As mentioned above the code obligations of good faith. For the most part. The general rule in sales law is that the parties are free to contract regarding most basic terms—quality. 2. If parties estimate the quantity involved. the quantity must be included. while the buyer accepts the goods and pays the price. there are two concepts of ownership that are fundamental to sales transactions: the notion of identiﬁcation and the concept of title. title to the goods is exchanged for a price. nor can a consequential damages’ limitation be unconscionable. Additional concepts in sales contracts In addition to these elements of the sales contract. • sale—In a sales transaction. parties—All parties involved or aﬀected must be described. because goods delivered on approval are not subject to the claims of the buyer’s creditors until the buyer has indicated acceptance of goods. a liquidated damages clause cannot be a penalty. the contract is unenforceable. the contract will be enforced at a reasonable price. before an agreement is considered enforceable. it means designated as the speciﬁc goods that will be utilized in the transaction. time for performance—If time is omi�ed. Frequently. etc. where the goods are delivered for use. On identiﬁcation of goods to a contract. If. a special property interest (see deﬁnition 8 .Certiﬁed Bank Auditor Examination Review — Volume 7 • future goods—Future goods are goods that are not in existence at the time of the agreement or have not been identiﬁed. a quantity unreasonably disproportionate to the estimate will not be enforced. damaged or destroyed. and (3) the code and other applicable statutes. Express elements required for sales contracts: 1. subject ma�er—Typically. • merchant—A merchant is a person who deals in the goods being sold or who holds himself out as having knowledge or skill peculiar to the goods involved in the transaction. (2) the course of dealing. if no mention of quantity is found. In a consumer purchase. quantity. 4. which means the non-breaching party can terminate performance and sue for damages. an estimate is not agreed on a quantity in keeping with normal or other comparable prior output or requirements may be implied. Goods delivered sale on return are subject to the claims of the buyer’s creditors while in the buyer’s possession. then reasonable time is implied. It is called a sale on return when the goods are delivered for resale. The Sales Contract Three sources supply the terms of a sale contract: (1) the express agreement of the parties. The responsibilities of the two parties (buyer and seller) involved are measured by the contract. If something is identiﬁed. however. In addition. delivery. This distinction is also important in cases where goods are lost. If the contract states time is of the essence. diligence and due care cannot be disclaimed.
and the location of title becomes an issue. The buyer must cover the inspection expenses. since a sale involves the passing of title from the seller to the buyer. If. title passes at the time and place the warehouse receipt is delivered. The parties can determine by their contract how title will pass. the buyer can recover the inspection expenses from the seller. identiﬁcation occurs when the seller ships the goods or speciﬁes them as the goods to which the contract refers. For example. the buyer still has the right to pursue remedies. 9 . The general rule is that the title acquired by a purchaser of goods is only as good as the title of the transferor. If the transfer of title is not speciﬁed in the contract. title passes when the seller tenders the goods to the buyer at the destination point. and (4) the right to demand the goods upon oﬀering the full contract price. the buyer has the right to inspect the goods at a reasonable time and place and in any reasonable manner. Most o�en title passes to the buyer at the time and place at which the seller completes his performance as to physical delivery of the goods. Methods of Accepting Goods. If a transferor transfers title to a buyer where: (1) the transferor is deceived as to the identity of the purchaser. The second concept is that of title. (3) it was agreed to be a cash sale or (4) the delivery was procured through fraud. (2) the right to inspect the goods at a reasonable time and at the buyer’s expense. (2) the delivery is in exchange for a bad check. this right does not adhere. Special property interest means the buyer has (1) an insurable interest in the goods. if the seller becomes insolvent within ten days of the buyer’s ﬁrst payment. the code sets forth speciﬁc provisions regarding to whom the title shall pass. the good faith purchaser receives full title and it ceases to be voidable by the original transferor. When the seller has no title. the purchaser receives no title. title passes at the time and place of shipment. • If a destination contract. Effect of Acceptance and Rejection Before payment or acceptance of goods. if the goods are in a warehouse and the seller delivers the warehouse receipt to the buyer. The original owner of the goods retains the title and may recover the goods. • If the seller has no duty to move the goods.Chapter One — Uniform Commercial Code below) in the goods is created on behalf of the buyer. • If a shipment contract. • With future goods. the buyer receives a voidable title. If the buyer makes payment prior to inspection and the subsequent inspection reveals defects. Rejection. title passes when the seller completes performance with respect to physical delivery. title passes on the delivery of documents of title. Rules for Title Passing There are speciﬁc rules that apply to the passage of title in the sales context. • Usually. the buyer with voidable title sells to a good faith purchaser for value of the items. however. If insolvency occurs before the ﬁrst payment. This interest may be created before the passing of title or delivery or possession of the goods. If the goods are nonconforming and the buyer rejects them. (3) the right to sue for damages caused by any third party who wrongfully destroys or damages the goods. This means that the seller may void the buyer’s title to the items he has received.
. The seller must notify the buyer of his intention to cure. Since the buyer has a security interest in the goods in his possession. a buyer who rejects received goods must hold the goods with reasonable care long enough for the seller to recover them. The buyer fails to make an eﬀective rejection of the goods. This can happen if the defect was not immediately discoverable when the goods were accepted or because the buyer assumed that the seller would substitute conforming goods. deduct all expenses relating to care. However. he has the right to resell them. Cure allows the seller to correct the defective performance. The buyer may collect from the seller the diﬀerence between the cost of the substitute goods and the contract price plus any incidental or consequential damages. the buyer must notify the seller within a reasonable time a�er the goods are tendered or delivered. The buyer should give detailed information regarding the reason for the rejection. Cover means to purchase the needed goods from another source to substitute for those due from the seller. The buyer acts in a manner inconsistent with the seller’s ownership. the buyer indicates to the seller that the goods are conforming or that he will keep them in spite of the non-conformity. he may still pursue remedy for damages for breach of contract even if the goods are accepted. 2. The buyer must notify the seller of revocation and revocation can occur only if the non-conformity substantially impairs the value to the buyer. but he does not have to obtain the substitute goods at the cheapest price available. the buyer may revoke his acceptance. The amount of damages is the diﬀerence between the contract price and the market price when the buyer learned of the breach plus any incidental or consequential damages. A buyer who does not receive the goods he bargained for may cover. a buyer of defective goods can reject and resell the goods. 3. resale. If the buyer notiﬁes the seller of the breach within a reasonable time. a buyer must act reasonably and in good faith. In this case. The buyer forfeits his right to reject defective goods if he possesses the goods for an unreasonable time. The buyer may deduct damages from the amount he owes the seller but the buyer must notify the seller of his intention to deduct damages. the buyer is placed in the same position relative to the goods as if he had rejected them in the ﬁrst place. Finally. A�er a reasonable opportunity to inspect the goods. Therefore. 10 . the buyer may reject all of the goods. and send any le� over money to the seller. Revocation of Goods Under special circumstances. the seller has the right to cure. To maintain the right to reject defective or non-conforming goods. There are three methods of accepting goods: 1. if the rejection is for a relatively minor deviation from the contract. In arranging cover. A buyer who does not receive any goods from the seller or who receives non-conforming goods does not have to cover but may sue for damages. accept all of the goods or accept part of the goods.Certiﬁed Bank Auditor Examination Review — Volume 7 If the goods are non-conforming. etc.
1) If the seller is a merchant who deals in goods of the kind involved in the contract. A seller warrants the goods to be of the same general quality of the sample. Implied warranties can be disclaimed in writing if the language makes it plain that there is.e. an act or claim that interferes with an exclusive right of an owner). An infringement may occur when the buyer furnishes speciﬁcations to the seller for the manufacturer of the goods. 2. express warranties—Express warranties include any aﬃrmation of fact or promise which is not just sales talk or an opinion and which becomes part of the bargain. in fact. The implied warranty of ﬁtness is applicable to both merchants and non-merchants. A disclaimer of merchantability must include the word “merchantability. This warranty can only be disclaimed by speciﬁc language or in circumstances which make it clear that the seller is not vouching for the title. The buyer does not have to prove reliance on this aﬃrmation and the seller does not have to intend to create a warranty. 3. Disclaimers Warranty liability may be escaped or modiﬁed by disclaimers. implied warranties—Implied warranties arise as a ma�er of law and are legally present unless clearly disclaimed or negated. A disclaimer set forth in the same type and color as the rest of the contract is not eﬀective.. The good is warranted for the particular expressed purpose. 2) An implied warranty of ﬁtness for a particular purpose is created when the seller knows of the particular use of the good and knows the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods. A seller who is a merchant warrants the goods to be free of any rightful claim of infringement. (i.Chapter One — Uniform Commercial Code Warranties Several warranties may be involved in a contract and may be implied or expressly stated: 1. model or of his description. However. warranty of title—The seller warrants good title.” The disclaimer clause of the contract must be set forth in a conspicuous manner. an implied warranty. The warranty does not arise if the buyer’s knowledge is equal or superior to the seller’s. These remedies may be in addition to or in substitution of the remedies provided 11 . rightful transfer and freedom from any security interest or lien of which the buyer has no knowledge. The parties to a contract may limit the remedies available in the event of a breach of warranty. such as larger type or a diﬀerent color ink. This warranty means that the goods are ﬁt for the ordinary purpose for which goods of this type are used and will pass without objection in the trade. In this case the seller does not warrant against infringement. This warranty applies to new and used goods in most states unless the warranty is modiﬁed or excluded. an implied warranty of merchantability is created. and the buyer must protect the seller from any claims arising from such an infringement. and the seller may be liable if the good fails to so perform. Liability for the breach of an implied warranty is based on the public policy of protecting the buyer of goods. a disclaimer inconsistent with an express warranty is not eﬀective and the express warranty is enforceable. There are two kinds of implied warranties.
In addition. The following is a list of the remedies on an equivalency basis and in the order of importance. The contract is repudiated if assurance is not provided within a reasonable time. failure of performance (buyer fails to pay or seller fails to deliver) 3. a buyer must be unable to cover to obtain the speciﬁc performance. anticipatory repudiation by the buyer or the seller 2. Consequential damages for personal injury related to consumer goods cannot be limited. sue for the actual price of the goods Buyer’s Remedies 1. Either party may become concerned about the other’s future performance. Remedies for the Buyer and the Seller The code provides four remedies for the buyer and the seller in a breach of contract. a rightful or wrongful revocation of acceptance by the buyer Adequate Assurance Adequate assurance is a concept applicable to both parties in a sales transaction. Some provisions may allow a seller to cure a defect or cancel a transaction by refunding the purchase price and without further liability. resell the goods and recover damages 2. If the goods related to a contract have been identiﬁed and the buyer has been unable to make cover a�er a reasonable eﬀort to do so. not to exceed 30 days. A party who is concerned about the performance of another party can demand—in writing—that the other party oﬀer convincing proof that he will perform. The statutory remedy of replevin allows the buyer to reach the goods in the hands of the seller. the buyer may replevin the goods from the seller. The buyer could fall behind in payments or the seller could deliver defective goods to other buyers. reject the contract 3. on the other hand. Clauses limiting a seller’s liability cannot be unconscionable. the buyer may reach the goods in the hands of the seller 12 . Unique goods are typically goods that are not practically available from other sources. recover damages for non-acceptance 4. can be. a rightful or wrongful rejection by the buyer 4. Insolvency of Seller or Buyer If the seller becomes insolvent. cover (buy same goods elsewhere) and recover damages 2. The insecure party may then suspend performance while waiting for assurance. Damages for commercial loss. cancel the contract 3. recover damages for non-delivery 4. Common Methods of Breaching a Contract The four common methods of breaching a contract are: 1. Seller’s Remedies 1.Certiﬁed Bank Auditor Examination Review — Volume 7 by the code. sue to get the goods (speciﬁc performance or replevin) Buyer’s Right to Speciﬁc Performance and Replevin The buyer has the right to specify performance if the goods are unique and other circumstances make it equitable that the seller renders the required performance.
and/or stop any goods in transit to the buyer and recover them from the carrier. the buyer is just a general creditor of the seller. The seller then has a claim against the buyer for the diﬀerence between the price the buyer had agreed to pay (contract price) and the resale price. the seller may sue for the contract price of the goods if: • the buyer has accepted the goods • the goods were destroyed a�er risk of loss passed to the buyer • the resale remedy is not practicable In cases such as specially manufactured goods where the right to resell is not available. the seller may sue for damages when the buyer refuses to accept the goods or repudiates the contract. If. the goods are treated as 13 . the seller may collect the purchase price. If this measure of damages does not put the seller in as good a position as he would have had if the buyer had performed. the undelivered portion can be resold. This is the case as well if the goods are unﬁnished—the seller can resort to the remedy of resale— but only if he can show that the unﬁnished goods were intended for that particular contract. revoked acceptance 3. a seller may refuse to make any further deliveries. demand payment for all goods previously delivered under the contract. Furthermore. If an insolvent buyer receives goods on credit. Without these circumstances. The code requires that the seller use reasonable commercial judgment in determining which course of action will mitigate his damages. Also. On discovering that a buyer is insolvent.Chapter One — Uniform Commercial Code only if (1) the existing goods have been identiﬁed in the contract and (2) the seller becomes insolvent within ten days a�er receiving the ﬁrst installment payment from the buyer. if the buyer breaches or repudiates the contract prior to the identiﬁcation of the contract goods. Seller’s Rights on Buyer’s Default The seller may stop goods in transit or withhold delivery if the buyer has: 1. the seller can reclaim the goods only in the case of insolvency. on the other hand. If the buyer discovers a�er replevin that the goods do not conform to the contract. the seller is in possession of the goods when the buyer breaches. the seller can resell them. the seller can reclaim the goods by demanding them within ten days of their receipt by the buyer. wrongfully rejected a tender of goods 2. failed to make a payment on or before delivery 4. repudiated either a part of the goods or the whole contract It must be remembered that once the goods are in the buyer’s possession. If the buyer fails to pay for the goods when due. the seller may resell the goods. the measure of damages will include the proﬁt the seller would have made from full performance by the buyer plus incidental damages. If the seller sues for the price. if only part of the goods have been delivered. Damages are equal to the diﬀerence between the market price at the place for tender and the unpaid contract price plus any incidental damages incurred as a result of the buyer’s breach. the buyer may reject them. If resale is not a suﬃcient remedy.
under certain circumstances. If the seller obtains a judgment against the buyer. The seller is provided some psychological protection. If the seller does resell the goods. The seller has the right to cure. Negotiable instruments developed out of the commercial need for an instrument that would be readily accepted in lieu of cash and that would. 3. The three reasons behind the notice requirement are: 1. he must apply the proceeds toward satisfaction of the judgment. bank certiﬁcates of deposit. be freely transferable. The key to this section of the law is the ability or legal power of a transferor. An example of a dra� is a check. SECTION 1:3: ARTICLE 3—COMMERCIAL PAPER [B]Deﬁnitions: Negotiable Instruments & Commercial Paper A negotiable instrument has the capacity to pass like money from person to person and is used as a medium of exchange. Wri�en notice is preferred. therefore. The only requirement is that the buyer notiﬁes the seller of the defect in the good. This allows the seller to minimize his loss and the buyer’s damages. the seller may still resell the goods prior to collection of the judgment. 2. The party addressing and signing the dra� is the drawer. Commercial paper is a term used to describe certain types of negotiable instruments..Certiﬁed Bank Auditor Examination Review — Volume 7 if they belong to the buyer even if the goods are in the possession of the seller. Notice of Breach A buyer must give a notice of breach (i. A dra� is a wri�en order to some other entity to pay money to a third party. Three parties are involved in the consummation of a dra�. Any notice of alleged breach may be oral or in writing. It is also a special type of wri�en contract that represents credit and functions as a money substitute. the buyer is entitled to any goods not resold. The third party is referred to as the payee. This is because it became necessary to shield the transferee from most of the defenses that the primary party (maker) might have against the payee so that the primary party could not assert the defenses against the person to whom the instrument was transferred. All remedies are barred if the required notice is not given. The drawee is the party directed to pay the sum certain in money to the third party. notice of any alleged breach of express and implied warranties) within a reasonable time a�er the facts comprising the breach are discovered or should have been discovered using reasonable care. Each party who transfers the instrument is required to assume liability to pay in the event that the maker or other primary party fails or refuses to pay. A note is a wri�en promise to pay (other than a certiﬁcate of deposit) by a party—the maker— a sum certain in money to the order of another party—the payee or the bearer of the note. to transfer be�er rights than he possesses. A check is an order by the drawer directing the drawee (bank) to pay money to the payee of the check.e. If the buyer pays any balance due on the judgment. Hence this form of commercial paper includes promissory notes. The seller has time to arm himself for negotiation and litigation. 14 . Commercial paper consists of two basic types of negotiable instruments: dra�s and notes. The seller can stop worrying about potential liability a�er a reasonable amount of time.
1. The language must signify more than a request or authorization to pay. The signer may use his own name. Therefore. However. Requirements of A Negotiable Instrument The terms wri�en on the face of an instrument determine its negotiability. 2) The second requirement is that the instrument must contain an unconditional promise or order to pay a sum certain in money. as long as the method used is intended by the drawer to be a signature. Four basic requirements must be met for an instrument to be considered negotiable. A dra� must contain an order to pay. negotiable). or (3) at a ﬁxed 15 . must be in writing and signed by the drawer or maker 2. an instrument is not rendered conditional if the instrument states the consideration or the transaction from which the instrument arose or states that the instrument is secured by a mortgage or other security interest. therefore. a rubber stamp. 3) The third requirement of negotiability is that the instrument must be payable on demand or at a deﬁnite time. it must be a direction to pay. The promise or order must also be unconditional. a ﬁne distinction must be drawn between language that imposes the terms of another agreement (conditional promise. A promise or order is conditional if the instrument states that it is subject to or governed by another agreement. and the instrument is. The signature is not required to be at any particular location on the instrument. must be payable to order or to bearer 1) The ﬁrst requirement is that the instrument must be in writing and must be signed by the drawer or maker. The language “payable on demand” is normally used in notes. or if the instrument states that it is to be paid only out of a speciﬁed fund. must be payable on demand or at a deﬁnite time 4. if it is payable on sight or presentation. initials and last name or a recognized symbol. If the principal sum to be paid is deﬁnite. negotiability is not aﬀected by the fact that the instrument is to be paid with interest. must contain an unconditional promise or order to pay a sum certain in money 3. though the exact word “promise” does not have to be used. A negotiable instrument that does not specify a due date is o�en referred to as demand paper. an assumed name. or with a discount or addition for early or late payment. non-negotiable) and language that is simply informative (unconditional promise. An example of demand paper is a check. An instrument is payable at a deﬁnite time if the instrument states that it is payable (1) at a ﬁxed period a�er presentation. An instrument is payable on demand if it so states.Chapter One — Uniform Commercial Code and cashier’s checks. but it may be payable in foreign or domestic currency depending upon the individual instrument. The requirement that the instrument be payable in a sum certain in money means that the instrument may not be payable in cha�els (barley). in installments. in this area. (2) prior to a stated date. The mere wri�en acknowledgement that a debt exists (an IOU) is not a promise. non-negotiable. or if no time of payment is stipulated. The words “at sight” are used in dra�s.
not both parties. from the date of issue. or if the deﬁnite time is subject to an extension at the option of the holder or to extension to a further deﬁnite time at the option of the maker or acceptor. In addition. Interest starts at the date of the instrument or.” or in the alternative. on the other hand. 16 . An instrument may be payable to the order of a trust. and typed terms control printed terms. Where the instrument contains discrepancies. Order paper is created when the instrument states that payment will be made to the order of a designated payee or to anyone that such a payee may order or direct. The UCC states that an instrument is bearer paper if it is payable (1) to bearer. “Joe or John. e. 4) The fourth requirement of negotiability is that the instrument must be payable to order or to bearer. Order paper can be negotiated only by both endorsement and delivery. Instruments are also payable at a deﬁnite time if the deﬁnite time is subject to acceleration (if provided for in the instrument).” further transfer requires endorsement by both Joe and John. unless the words are ambiguous. Bearer paper means that payment will be made to anyone who possesses or bears the instrument. Additional Characteristics of Negotiable Instruments Additional wording o�en does not aﬀect the negotiability of an instrument. In this case. However. When an instrument provides for the payment of interest but does not state an interest rate. Also. (3) to a speciﬁed person or bearer. fund or estate. for example. this does not aﬀect negotiability. An instrument may be payable to the order of two or more payees together. the individual who signed the incomplete instrument must bear the loss because he made the wrongful completion possible. An incomplete instrument cannot be enforced. though a holder in due course (see below) can enforce the instrument as completed. then the ﬁgures control. Bearer paper can be negotiated by delivery without endorsement. An instrument may also be payable to the order of an oﬃcer.” If the instrument is payable to “Joe and John.” further transfer requires endorsement by either Joe or John. If the drawer includes a provision saying that by endorsing or cashing the instrument the payee acknowledges full satisfaction of an obligation by the drawer. an instrument can be completed by any individual in accordance with the authority or instructions given by the party who signed the incomplete instrument. the rate is set at the judgment rate at the place of payment. or (4) to cash or the order of cash. is treated as a material alteration of the instrument. Unauthorized completion. The words control. typed. However. the omission of language stating the consideration for which an instrument was given will not aﬀect the instrument’s negotiability.Certiﬁed Bank Auditor Examination Review — Volume 7 time a�er a stated date. The dating of an instrument is also not an essential requirement of negotiability. “Joe and John. or printed. If the instrument is payable to “Joe or John. The judgment rate is speciﬁed by statute.g. if it is undated. (2) to the order of bearer. An instrument may also contain a discrepancy between the words and the ﬁgures. a promise to pay Joe $250 upon John’s death. handwri�en terms control typed and printed terms. an instrument may contain terms that are handwri�en.. An instrument will be deemed non-negotiable if the instrument is payable only on the occurrence of an event or act uncertain as to the time of occurrence.
With negotiation. If the instrument is bearer paper. There are two exceptions to the rule that an authorized agent’s signature does not bind the principal. An agent who fails to name his principal or who lacks the authority to bind his principal will be liable to third parties. The agent’s liability to third parties is based on the premise that a purchaser of commercial paper is entitled to rely on what appears on the face of the instrument. For example. Negotiation is a particular type of transfer by means of which the transferee becomes a holder. An individual is a holder if he is in possession of an instrument drawn. Endorsers normally sign on the back of the instrument. the person to whom it is transferred may receive full rights as if it had been transferred directly from the issuer. waiver. even if the signature is properly authorized. both endorsement and delivery are required. If it is not payable to order or to bearer 2. Liability of Commercial Paper The liability of an individual in a commercial paper transaction is predicated either on the instrument itself or on the underlying contract. the endorsement must convey the entire instrument or any unpaid balance on the instrument. the drawee (bank) may not pay on only one signature. If it is payable on the occurrence of an uncertain event An instrument may be transferred by either negotiation or assignment. guarantee. and makers and drawers generally sign in the lower right-hand corner on the face of the instrument. or limitation or disclaimer of liability. When an agreement requires two signatures. However. Ambiguous signatures that fail to show the capacity of the party who signed the instrument are treated as endorsements.Chapter One — Uniform Commercial Code an individual who is not a holder in due course is subject to the defense of improper completion. The transfer of an instrument vests in the transferee the rights that the transferor possesses. only delivery is required for negotiation. to bearer or in blank. if an instrument is payable to bearer and it is stolen by a thief or found by a ﬁnder and they transfer the instrument to another person. A person is not liable unless his signature appears on the instrument or unless his signature has been placed on the instrument by his duly authorized agent. his order. if the instrument is order paper. issued or endorsed to him. Characteristics of a Non-negotiable Instrument 1. The principal must assume liability if (1) he ratiﬁes the transaction or (2) if he is stopped from asserting lack of authority. a transferee may obtain greater rights than were held by the transferor. For the negotiation to be eﬀective. The endorsement will still be eﬀective even if the endorser adds to his endorsement words of assignment. 17 . Duly authorized acts by an agent will bind the principal. The location of a person’s signature usually will denote the capacity in which the person signed. An agent will also be liable if he fails to exhibit his representative capacity.
If a check is duly presented for payment to the payor bank otherwise than for immediate payment over the counter. endorsers. and guarantors are all considered secondary parties. Secondary parties consist of drawers of dra�s and checks and endorsers of any instrument. The term conditional refers to the required conditions precedent that 18 . The words of guarantee determine the liability of the guarantor. the check is dishonored if the payor bank makes timely return of the check or sends timely notice of dishonor or non-payment under Article 4 provisions (4-301&4-302). is dishonored and if notice of dishonor is provided to the endorser. An endorser who adds the words “without recourse” to his endorsements is required to pay only if the instrument is properly presented to the primary party. On certiﬁcation.Certiﬁed Bank Auditor Examination Review — Volume 7 Parties to Commercial Paper The parties to commercial paper transactions may be subdivided into primary and secondary parties. such as drawers and endorsers is o�en referred to as conditional liability. an endorser of an altered instrument assumes liability on the instrument as altered. they will be deemed to constitute a guarantee of payment. Unqualiﬁed endorsers are secondarily liable on instruments by virtue of their contract of endorsement. An individual who lends his name and credit to another party by signing an instrument is referred to as an accommodation party. he will pay the amount of the dra� to the holder or to any endorser. The secondary liability of parties. If an endorser guarantees payment. the guarantor is obligated to pay the instrument (if it is not paid when due) without prior resort by the holder to other parties on the instrument. notice of dishonor and protest. A guarantor is one who contracts to answer for the debt. default and miscarriage of another. The accommodation party is liable in the capacity in which he signed. accommodation parties. or becomes accountable for the amount of the check under Section 4-302. The accommodation party may sign as a maker. the bank becomes the principal debtor because the bank appropriates from the depositor’s account the necessary funds to pay the instrument. The drawer engages that on the dra�’s dishonor and any necessary notice of dishonor or protest (see deﬁnition below). A primary party engages that he will pay the instrument according to its terms at the time of execution. acceptor. If the words of guaranty on the instrument are unclear. The endorser obligates himself to pay the instrument according to its terms. The words “collection guaranteed” means that the guarantor is liable only a�er the holder has a�empted to collect from all other parties. Secondary Parties Drawers. An important factor to be remembered is that the drawee bank is not liable on a check until acceptance. endorser. If the words “payment guaranteed” are added to the guarantor’s signature. he waives the conditions precedent of presentment. co-maker or co-acceptor. Drawers and endorsers have a secondary responsibility: an obligation to pay if the primary parties do not pay provided certain precedent conditions are fulﬁlled. but his primary function is that of a surety. Therefore. Certiﬁcation is the usual method of accepting a check. Primary parties consist of the makers of notes and the acceptors of dra�s and are the parties who will actually pay the instruments.
According to the UCC. Bearer paper when specially endorsed becomes order paper. Further negotiation requires the endorsee’s signature. An example of a qualiﬁed endorsement is when the transferor disclaims any liability on the instrument by including the words “without recourse” in his endorsement. As stated earlier. 19 . If the third party possesses a negotiable instrument that has been improperly negotiated. A holder in due course has a special status and a preferred position in the event there is a claim or a defense to the instrument. a holder.Chapter One — Uniform Commercial Code must be satisﬁed to establish secondary liability. Restrictive endorsements are substantially limited as applied to banks that are involved in the deposit and collection of negotiable instruments. a transferor. or a holder in due course. endorsers of commercial paper warrant that the instrument has not been materially altered and that all signatures are good. Blank Endorsements Special Restrictive Qualiﬁed Restrictive Qualiﬁed A restrictive endorsement restricts the endorsee’s use of the instrument and does not prevent further transfer or negotiation of the instrument. the third party is an assignee. protest. A special endorsement speciﬁes the party (endorsee) to whom or to whose order the endorsement makes the instrument payable. A blank endorsement is simply the endorser’s (customer’s) signature. the conditions precedent are presentment. The UCC provides that any restrictive endorsement may be disregarded by an intermediary or payor bank that is not a depository bank. Blank or special endorsement can be restrictive or qualiﬁed. Failure to comply with the conditions precedent will result in either the partial or complete discharge of the secondary parties. A blank endorsement converts order paper to bearer paper. to him. An example is “Pay to John Smith without recourse. This limitation does not aﬀect any rights the restrictive endorser may have against the depository bank. drawn. Paul Jones. dishonor. or endorsed to his order. A restrictive endorsement is o�en used when a check is deposited in a bank for collection (“For deposit only. in some circumstances. a holder is a party in possession of a negotiable instrument issued. the party is a transferee with the status of an assignee. Paul Jones”). except that of the bank’s immediate transferor. This type of endorsement does not prevent the transferee from being a holder in due course. The distinct beneﬁt of negotiability is the ability to transfer the instrument to a holder in due course. There are two basic classes of endorsements: blank or special. Classes of Endorsements In general. to bearer or in blank. or his rights against parties outside the bank collection process. If the instrument is a simple contract.” Holder in Due Course A third party who rightfully and legally possesses an instrument may be an assignee. notice of dishonor and.
Warranties Secondary parties are also subject to unconditional liability for breach of implied warranties. Here are a few examples: 1. Value does not have the same meaning as consideration in the law of contracts for Article 3 of the UCC. and the purchaser is then not a holder in due course. he cannot meet the requisites of a holder in due course. 4. Purchase of an instrument for less than its face value by a holder may still qualify the party as a holder in due course for the instrument’s full amount. Consideration and Good Faith There are three requirements that must be met before a holder becomes a holder in the due course. value is any consideration suﬃcient to support a simple contract for all of the UCC except in Article 3 and 4. A person who purchases an instrument with notice that it previously has been dishonored cannot qualify as a holder in due course. has been dishonored. the party has not acted in good faith. or if he takes it more than a reasonable length of time a�er its issue. then an individual exercising reasonable care will assume that it exists. A personal defense. it does establish value. therefore. A reasonable or unreasonable length of time is determined on the basis of the a�endant facts and circumstances. on the other hand. (2) in good faith. 3. A purchaser of demand paper cannot qualify as a holder in due course if he has reason to know that he is purchasing it a�er a prior demand for payment has been made. forgery of a necessary signature. a check is presumed to have a reasonable time period of 30 days a�er its initial issue. or if there is such a strong probability that it exists. In Article 3. Real and Personal Defenses A real defense is a type of defense that is good against any possible claimant. an executory promise will not meet the value requirement to be a holder in due course. Instruments that are incomplete in some material respect at the time of their purchase provide suﬃcient notice to the purchaser. if the promise to pay is negotiable in form (a negotiable note). However. In fact. 20 . and (3) without notice that is overdue. The holder must have acquired the instrument (1) for value. A purchaser of an overdue instrument is charged with knowledge that some defense may exist. Case law commonly provides that a person has reason to know if he possesses information from which an individual of ordinary intelligence will conclude that the fact exists. If a party accepts an instrument when he knows—or has reason to know—of a claim or defense. 2. etc. Examples are: fraud in fact. However.Certiﬁed Bank Auditor Examination Review — Volume 7 Value. is an ordinary defense in a contract action—such as failure of consideration or non-performance of a condition—which argues that the maker or drawer of a negotiable instrument is precluded from raising against a person who has the rights of a holder in due course. or any other person has a claim to or defense against it. so the maker or drawer of a negotiable instrument can raise it even against a holder in due course.
it is o�en required in the case of dra�s. notice of dishonor must be given before midnight of the third business day a�er dishonor. Presentment and Dishonor Presentment means a demand made by—or on behalf of—a person entitled to enforce an instrument (1) to pay the instrument made to the drawee or a party obliged to pay the instrument or. The party presenting the instrument warrants that no endorsements are forged and that to his knowledge the signature of the maker or drawer is genuine. that the signatures appearing on the instrument are genuine or authorized. If the party to whom the instrument is presented refuses to accept or pay the instrument. or (2) to accept a dra� made to the drawee.. to the bank. The UCC permits any party who may be required to pay the instrument to notify any party who may be liable on it. The presenter also warrants that the instrument has not been materially altered.e. Drawers. The drawee of a dra� is not bound until acceptance of the dra� by the drawee.Chapter One — Uniform Commercial Code Warranties are made when an instrument is transferred or presented. Presentment for acceptance does not apply to promissory notes. Such an unexecuted delay completely discharges all endorsers. and acceptors of dra�s payable at a bank are discharged to the extent of any loss 21 . Presentment may be for acceptance or for payment. Presentment may be made in person. the midnight deadline). However. The holder has an immediate right of recourse against the secondary parties who receive a prompt notice of the dishonor. that the instrument has not been materially altered.) Presentment by mail is eﬀective on the date the mail is received. Notice may be conferred in any reasonable manner including oral notice and notice by telephone or mail. Failure to make a proper presentment for payment results in the complete discharge of an endorser. (an association of banks or other payors who regularly clear items. and that no defense of any party is good against him. makers of notes payable at a bank. then the instrument is dishonored. and evidence of the individual’s authority to present the instrument. Presentment also may be required at a location speciﬁed in the instrument. By endorsing the instrument. Wri�en notice is eﬀective when sent even if it is not received. Presentment for payment is normally suﬃcient and presentment of an instrument for acceptance is not required. the transferor warrants that he has good title to the instrument. by mail or through a clearinghouse. Failure to provide prompt and proper notice of dishonor may result in the discharge of the endorsers. The party to whom the instrument is presented may without dishonor require the instrument’s exhibition. assuming proper address and postage. However. The presenting party then has recourse against all endorsers and other secondary parties if notice of dishonor is provided to these secondary parties. banks must provide notice before midnight of the next banking day following the day on which a bank receives the item or notice of dishonor (i. in the case of a note or accepted dra� payable at a bank. An unexcused delay in making a necessary presentment or in giving notice of dishonor discharges all parties who are entitled to performance of the conditions precedent. Generally. reasonable identiﬁcation of the individual making presentment.
An oral stop order is eﬀective for only fourteen calendar days unless conﬁrmed in writing within that time. Setoﬀ gives the bank the right to deduct debts from a customer’s account if it becomes necessary.Certiﬁed Bank Auditor Examination Review — Volume 7 caused by the delay. a bank has a duty to honor his checks. This article provides the rules that govern the interrelationships of banks and banks’ relationships with depositors in the collection and payment of items. then any delay in making presentment. An overdra� is a loan made outside the lending process. savings deposits.4: ARTICLE 4—BANK DEPOSITS AND COLLECTIONS Purpose of Article 4 Article 4 of the UCC governs the collection by banks of checks and other instruments for the payment of money. Only the drawer has a right to stop payment on checks on his account. Protest Protest is a formal method of fulﬁlling the conditions precedent. drawee. A borrower has a debtor-creditor relationship with the bank. SECTION 1. Protest is required only for dra�s that are drawn or payable outside the U. A wri�en stop order is binding 22 . and if the delay is not the fault of the holder. and share dra�s (a Certiﬁcate of Deposit is not a deposit account) • depository bank—the ﬁrst bank to take an item even though it is also the payor bank. unless the item is presented for immediate payment over the counter • payor bank—the drawee of a dra� • intermediary bank—any bank to which an item is transferred in the course of collection except the depository or payor bank • collecting bank—any bank handling an item for collection except the payor bank • presenting bank—any bank presenting an item to a payor bank The Bank/Customer Relationship A bank and its depositors have a legal relationship of debtor and creditor. This dual relationship allows a bank to seize bank deposits under its right of setoﬀ. passbooks. A bank may honor a check even if there are insuﬃcient funds. or holder in due course on a certiﬁed check cannot issue a stop payment. in giving notice of dishonor or in making protest will be excused. The protest is a certiﬁcate which states that an instrument was presented for payment or acceptance and was dishonored.S. The bank is under no obligation to pay the overdra�. Article 4 Deﬁnitions • deposit accounts—time deposits. and explains why the instrument was not accepted or paid. If the holder acts with reasonable diligence. When there are suﬃcient funds in a customer’s account. demand deposits. A stop-payment order may be communicated to a bank by phone or in writing. A drawer. When in writing a stop payment may be in the form of a le�er to the bank or on a bank’s stop-payment form. A bank must receive the stop-payment order in a time and manner that allows it to actually stop payment before taking any other action on the item. This creates an overdra� for which the customer is indebted to the bank.
then the customer‘s account can only be charged for the amount intended. Further. 23 . a check that is over six months old (i. Even if the bank was negligent. (2) it paid the check in accordance with reasonable commercial standards. but the customer needs to give the bank prompt notiﬁcation of a forged check. a stale check) and may then charge the customer’s account. If a bank honors a check that a customer signed when it was incomplete and then it is completed by another person. the drawer must have a valid reason to stop payment.e. the bank is liable to the drawer of the check for any loss. the auditor should be aware that the bank can be absolved of liability if it can establish that (1) it paid the check in good faith. This six-month rule does not apply to certiﬁed checks. The customer has the burden of establishing the amount of the loss. but is not obligated to pay. For forged endorsements. A bank may pay. The customer should examine the canceled checks for forgeries and alterations. If a bank honors an altered check in good faith. Responsibilities Bank customers are under a duty to examine their bank statement and canceled checks within a reasonable time a�er receipt. Audit Focus Point During a review of checking account-related forged endorsement fraud losses. the period is three years. a bank must act in good faith and use ordinary care. If a bank honors a check with a stop-payment order on it. With wrongful dishonor that is willful.. the customer’s account can be charged if the bank pays in good faith and does not know that the completion was improper. The bank cannot disclaim its responsibility for not obeying stop-payment orders by having the customer sign an agreement not to hold the bank responsible. if the customer can establish that the bank was negligent. If the customer’s negligence led to the alteration and the bank paid without being negligent. punitive damages may be awarded along with the actual damages. If the bank can prove that it would suﬀer a loss due to the lack of prompt notiﬁcation. therefore. The bank does not have the right to charge a customer’s account for forged checks. a customer cannot assert forgery of the drawer’s signature or alteration on a check a�er one year from the time the canceled check and bank statement were made available. a bank is liable to its customers for damages caused by a wrongful dishonor. The bank cannot use the defense of lateness in examining and reporting. In paying stale checks. The liability for a dishonor by mistake is limited to the actual damages proved. then the customer will be prevented from asserting the forgery or alteration against the bank. which are an obligation of the certifying bank. the bank can charge the customer’s account for the altered amount. This can include consequential damages.Chapter One — Uniform Commercial Code for only six months unless renewed in writing.
The bank may endorse the item as deposited by a customer or credited to his account. it may allow a customer to draw against uncollected funds. notice or payment. The beginning of the collection process is the deposit of a check into a customer’s account. A depositor has no right to withdraw against uncollected funds. notice or payment by midnight the next day.” In order to have time to process items. The customer’s account is then debited for the check which is returned to the customer. the depositor cannot draw against an item payable by another bank until the provisional se�lement is ﬁnal. On the other hand. The drawer’s account is debited when the check reaches the payor-drawee bank.m. The collection process involves sending the check through various banks that credit and debit accounts they maintain with each other. the bank is obligated on the item. The collecting banks must return the check or send notiﬁcation of the fact by the midnight deadline. If the check is dishonored. it is not necessary to return items to customers for endorsement. In most cases. If a customer forgets to endorse a check. or later. the depository bank may supply the missing endorsement. even though a bank has no legal duty to do so. for someone who is not a customer. Final Payment On ﬁnal payment. A bank has the duty to use ordinary care in its collection operations or it may be liable to the depositor for any loss or damage sustained. prove balances and make necessary entries. Final payment occurs when: • the item is paid in cash • the item is se�led without reserving the right to revoke the se�lement • the process of posting the item is complete • a provisional se�lement is made and not revoked within the prescribed time 24 . must be sent to the drawee bank for payment. A banking day is “that part of any day of which a bank is open to the public for carrying on substantially all of its banking functions. Therefore. a bank cannot supply an endorsement. deposited or presented for payment in a bank other than the bank on which it is drawn. se�lement is ﬁnal. a bank must take proper action following receipt of a check. The bank then provisionally credits the check.Certiﬁed Bank Auditor Examination Review — Volume 7 The Bank Collection Process Collections A check. A bank must take proper action before the midnight deadline following the receipt of a check. If a bank does not act reasonably. the presenting bank will reverse its provisional se�lement and charge the item back to the account of the next prior collecting bank and so on back to the depository bank. The exception to this is if the bank is excused by ma�ers beyond its control. Items received a�er the cutoﬀ hour are treated as being received on the next banking day. though excuses are usually diﬃcult to establish. Regional Federal Reserve Banks play an important role in this process. In other words. banks establish a cutoﬀ hour of 2 p. Timing is an important factor in the process of check collection. which themselves provisionally credit the amount of the prior bank. If the check is honored. The check passes through the various collecting banks. it is liable. However.
or (2) that such a credit will be honored by the issuer or a third bank • customer—buyer or other person who causes an issuer to issue a credit Usage of Letters of Credit Le�ers of credit include: 1. governed by Article 5 of the UCC. the bank is liable to the depositor if it: • retains a check presented to it by another bank • does not pay or return the check.e. a paper such as a document of title. A le�er of credit is an idiosyncratic form of undertaking that supports performance of an obligation incurred in a separate ﬁnancial. certiﬁcate. security. If a check is not paid.e. a credit issued by a bank or other person that conspicuously states that it is a le�er of credit or is conspicuously so entitled A le�er of credit may be used alone instead of in conjunction with a documentary sale of goods. It also may function as a medium of payment or as a back up against customer 25 . etc. or other transaction or arrangement. where the depository bank is the payor bank) the item becomes ﬁnal on the opening of the second banking day following receipt of the item. or send notice of dishonor within the period of its midnight deadline SECTION 1.Chapter One — Uniform Commercial Code If a check drawn by a customer of a bank is deposited by another customer of the same bank (i. mercantile. • beneﬁciary—person entitled under the terms of a credit to draw or demand payment • advising bank—bank that gives notiﬁcation of the issuance of a credit by another bank • conﬁrming bank—bank that engages either (1) that it will itself honor a credit already issued by another bank. a credit issued by a person other than a bank if it requires that the dra� or demand for payment be accompanied by a document of title 3.) • issuer—a bank or other person issuing a credit. a credit issued by a bank if it requires a documentary dra� demand for payment or documentary 2. Article 5 Deﬁnitions • le�er of credit—engagement by a bank or other person at the request of a customer that the issuer (bank or other person) will honor dra�s or other demands for payment upon compliance with the conditions speciﬁed in the credit (may either be revocable or irrevocable—see below) • documentary dra� or documentary demand for payment—honor conditioned upon presentation of a document (i. This section will make clear what a le�er of credit is and precisely what circumstances Article 5 encompasses. has undergone signiﬁcant development since the original dra�ing of that article. invoice..5: ARTICLE 5—LETTERS OF CREDIT Purpose of Article 5 Le�ers of Credit.
An Example Le�ers of credit are used in both international and domestic trade. wants to buy cloth manufactured in France by the French Co. then draws a sight dra� (a dra� that is payable on the bearer’s demand or on proper presentment to the drawer) to its order showing the French Co.—the beneﬁciary—on proper presentment of the dra� and any other required documents including the bill of lading. as beneﬁciary with authority to draw dra�s on the issuing bank. the bill of lading and any other necessary documents and mailed to French Co. but they originated in international trade. a California company.’s agent (usually a correspondent bank) in California with instructions to deliver the bill of lading properly endorsed if and only if the le�er of credit issuer properly pays the sight dra�. would then obtain a le�er of credit from its bank. Once an irrevocable le�er of credit is established with the 26 . it is the la�er. A bank. Types of Letters of Credit There are two types of le�ers of credit: revocable and irrevocable. to pay the dra� on presentment. puts the goods on board a carrier and receives a negotiable bill of lading drawn to French Co. When the beneﬁciary receives a le�er of credit or an authorized wri�en advice of its issuance. then the issuing bank must pay. They function like guarantees in that customer default triggers the issuer’s obligation. With the documentary sale. insurance company. If the presented documents comply with the conditions stated in the le�er of credit. answers that it will not pay in advance. or the le�er of credit or an authorized wri�en advice of its issuance is sent to the beneﬁciary. Any modiﬁcations of the terms of a le�er of credit or conﬁrmation must be signed by the issuer or conﬁrming bank. This le�er of credit would be issued by the bank showing French Co. ABC Co. ﬁnance company or other similar organization may issue le�ers of credit. Typically. a le�er of credit is established in two ways. When a le�er of credit is sent to the customer. it is the former. replies that it will not sell on open credit. as the drawer and directing ABC Co. This bill of lading is the title to the goods. the customer or the beneﬁciary. The customer and beneﬁciary may agree on another time of establishment of credit. ABC Co. French Co. Conﬁrmations must also be in writing and signed by the conﬁrming bank. The following is an example of the use of a le�er of credit in international trade: ABC Co. and ABC Co. Any irrevocable le�er of credit would commit the bank—the issuer—to pay a dra� drawn by French Co. Formal requirements necessitate that a le�er of credit must be in writing and signed by the issuer. that says nothing about payment terms.. This dra� is then sent with the le�er of credit. French Co. The two companies agree to a documentary sale along with a le�er of credit. sends a proposal to French Co. or consent by. Le�ers of credit used as back up are called standby le�ers of credit. either with regards to the customer or with regards to the beneﬁciary. French Co.Certiﬁed Bank Auditor Examination Review — Volume 7 default on ﬁnancial or other obligations. it can be modiﬁed or revoked by the issuer without notice to. Once a revocable le�er of credit is established.
demand or document in transit or in the possession of others • based on knowledge or lack of knowledge of any usage of any particular trade A beneﬁciary in transferring or presenting a documentary dra� or demand for payment warrants to all interested parties that he has complied with the conditions required by the le�er of credit. the beneﬁciary may assign his right to proceeds.6: ARTICLE 8—INVESTMENT SECURITIES Purpose of Article 8 Article 8 of the UCC establishes the rights and duties of the parties involved with both certiﬁcated and uncertiﬁcated investment securities. An issuer’s obligation does not include liability or responsibility: • for performance of the underlying contract for sale or other transaction between the customer and the beneﬁciary • for any act or omission of any person other than itself. SECTION 1. This applies regardless of whether the goods or documents conform to the sale contract. The right to proceeds may be assigned prior to performance of the conditions of the le�er of credit but not a�er performance. If an issuer wrongfully dishonors a dra� or demand for payment. the presenter has the rights of a person in the position of a seller and may recover the face amount of the dra� or demand plus any incidental damages. the beneﬁciary can wait a reasonable time for performance by the repudiating party. An issuer must honor a dra� or demand for payment which complies with the terms of the applicable le�er of credit. it constitutes dishonor of the dra� or demand. it can only be modiﬁed or revoked with the customer’s or beneﬁciary’s consent. On dishonor.Chapter One — Uniform Commercial Code customer. A bank that has been presented with a documentary dra� or demand for payment may defer honor until the close of the third banking day following receipt of the documents. or for loss or destruction of a dra�. Article 8 sets forth the rules relating to the transfer of the rights that constitute securities and the establishment of those rights 27 . Even if a credit is non-transferable or non-assignable. He can also resort to a remedy for breach of contract and/or suspend his performance. the bank must notify the presenter that it is holding the dra� or demand for return to the presenter. If the bank does not honor the dra� within the speciﬁed time period. Transfers and Assignments Le�ers of credit can be transferred or assigned only if they are designated as transferable or assignable. Honor may be deferred even later if the presenter consents. If an issuer wrongfully cancels or repudiates a credit before presentment. Obligations of Issuers An issuer has two obligations to its customer (1) good faith and (2) observance of any general banking usage.
Certiﬁed Bank Auditor Examination Review — Volume 7 against the issuer and other parties. interests or obligations are uncertiﬁcated securities 28 . or other interests in property or an enterprise. if the security so states 4. either one of a class or series. it speciﬁes a person entitled to the security or the rights it represents b. participations. or (2) undertakes obligations in which shares. are subject to regulation by a federal or state governmental authority 6. participation. clearing corporation— a. of a type commonly traded on securities exchanges or markets c. including promulgation of rules. the issuer is deﬁned as the person who: • places or authorizes the placing of his name on a certiﬁcated security (1) to evidence that it represents a share. or (2) to evidence his duty to perform an obligation represented by the certiﬁcated security • (1) creates shares. participation or other interest in property. if its activities as a clearing corporation. interests or obligations of the issuer. subsequent purchaser—a person who takes other than by original issue 5. or recognized in the areas in which it is issued or dealt as a medium for investment c. or an obligation of the issuer which is: a. Article 8 Deﬁnitions 1. or by its terms divisible into a class or series of shares. or by its terms divisible into a class or series of shares. any other person that provides clearance of se�lement services with respect to ﬁnancial assets that would require it to register as a clearing agency under the federal securities laws but for an exclusion or exemption from the registration requirement. either one of a class or series. participation or other interest in the property of an enterprise of the issuer. uncertiﬁcated security—a share. its transfer may be registered on books maintained for that purpose by or on behalf of the issuer c. a federal reserve bank c. represented by an instrument issued in bearer or registered form b. an enterprise 3. not represented by an instrument and whose transfer is registered on books maintained for that purpose by or on behalf of the issuer b. participation. a person that is registered as a clearing agency under the federal securities laws b. participation. of a type commonly traded on securities exchanges or markets. or an obligation of the issuer which is: a. certiﬁcated security—a share. or other interest in property or an enterprise. custodian bank—A bank or trust company that is supervised and examined by the state or federal authority having supervision over banks and is acting as custodian for a clearing corporation[B]Issuer Liability Rules Deﬁnition of Issuer When there are obligations on or defense to a security. registered form (re: certiﬁcated security)—a certiﬁcated security is in registered form if: a. participations. interests or obligations 2.
Chapter One — Uniform Commercial Code • creates fractional interests in his rights or property which are represented by certiﬁcated securities • becomes responsible for or acts in place of any other person described as an issuer above Deﬁnition of Guarantor A guarantor is an issuer to the extent of his guarantee. pledge or release. 3. 2. Another alternative is that the person may transfer an uncertiﬁcated security of the same issue. Issuer’s Liens A lien on a certiﬁcated security in favor of the issuer is valid against the purchaser only if the issuer’s right to the lien is noted conspicuously on the security. 29 . 5. the issuer is the person on whose behalf transfer books are maintained. With regards to registration or transfer. on an initial transaction statement or on an instruction) is admi�ed unless speciﬁcally denied in the initial pleading by the issuer. the plaintiﬀ must establish the fact that the defense or defect is ineﬀective against him. the burden of establishing eﬀectiveness is on the party claiming under the signature. If the purchaser’s interest is received other than by registration of transfer. a notation of the issuer’s right to the lien must be included in the initial transaction statement sent to the purchaser. If signatures on a certiﬁcated security are admi�ed or established. If the eﬀectiveness of a signature is at issue. pledge or release. Therefore. The rights and interests related to securities of the same issue are considered fungible. the initial transaction statement must be sent to the registered owner or to the registered pledgee. presentation of the security entitles the holder to recover on it unless the defendant establishes a defense or a defect related to the validity of the security. 4. State Law The law of the state in which the issuer is organized determines the rights and obligations of the issuer with respect to securities. Each signature on a certiﬁcated security (in a necessary endorsement. any facts presented in the statement are presumed to be true at the time it was issued. The issuer is free to show that later events changed the stated facts. If signatures on an initial transaction statement are admi�ed or established. a person obligated to transfer securities does not have to transfer a speciﬁc instrument but may select any security of the proper issue. If the security is uncertiﬁcated. The signature is presumed to be genuine or authorized. whether it is in bearer form or appropriately registered or endorsed. Rules for an Action The following rules apply in an action brought against the issuer of a security to enforce a right or interest that is part of the security: 1. A�er it is shown that a defense or defect exists.
but only according to its original terms. pledges or releases the uncertiﬁcated security. registrar. Even if the blanks are incorrectly completed. If the endorsement is on a separate document. the restriction is ineﬀective against a person without actual knowledge of it. A blank endorsement includes an endorsement to bearer. However. If the purchaser transfers. If a certiﬁcated security or initial transaction statement includes authorized signatures but is incomplete in any other respect. An altered certiﬁcated security or initial transaction statement is enforceable. the transferee may obtain the initial transaction statement from the registered owner or registered pledgee. pledge or release of the security is both within his capacity and within his scope of authority as granted by the issuer • the security is in the form and within the amount the issuer is authorized to issue Unless a purchaser's rights are limited. If an issuer does not have a restriction in any of these manners. Purchaser Liability Rules If the buyer does not pay the sale contract price the seller may recover the price of: • certiﬁcated securities accepted by the buyer • uncertiﬁcated securities that have been transferred to the buyer or a person designated by the buyer 30 . transfer agent. the terms of the security are included in the initial transaction statement sent to a purchaser. A person who signs a certiﬁcated security or initial transaction statement as authenticating trustee. A special endorsement speciﬁes to whom the security is to be transferred or who has the power to transfer it. the terms of the security are stated on the security. A restriction on an uncertiﬁcated security should be included in the initial transaction statement. the security is enforceable by a purchaser for value who had no notice of the incorrectness. With an uncertiﬁcated security. A blank endorsement may be converted into a special endorsement. or the like warrants to a purchaser for value that: • the certiﬁcated security or initial transaction statement is genuine • the signer's participation in the issue or registration of the transfer. he will on transfer of a security. any person may complete it by ﬁlling in the blanks. An unauthorized signature on a certiﬁcated security or initial transaction statement is enforceable by a purchaser for value only if the purchaser does not know that the signer does not have the authority. endorsement of a certiﬁcated security does not constitute a transfer until its delivery. acquire the same rights as the transferor (or those rights which the transferor had authority to convey). both the document and certiﬁcated security must be delivered. In other words.Certiﬁed Bank Auditor Examination Review — Volume 7 Terms of Securities If a security is certiﬁcated. a certiﬁcated security may be endorsed in blank and an endorsement may transfer only part of a certiﬁcated security. A purchaser of a limited interest acquires rights only to the extent of the interest transferred. A security may be endorsed in blank or special. An endorsement may transfer only part of a certiﬁcated security. A restriction on a certiﬁcated security should be conspicuously noted on the security.
for payment or for exchange. • The security is genuine and has not been materially altered. pledge or release of an uncertiﬁcated security is registered to the purchaser or his representative • the purchaser's ﬁnancial intermediary obtains possession of a certiﬁcated security specially endorsed to or issued in the name of the purchaser • the purchaser's ﬁnancial intermediary sends him conﬁrmation of the purchase and also identiﬁes the security as belonging to the purchaser by a book entry or otherwise • at the time a third person acknowledges that he holds a security for delivery to the purchaser • when appropriate entries regarding the purchase are made on the books of a clearing corporation Rules for Contracts for the Sale of Securities A contract for the sale of securities is enforceable if: • there is a writing signed by the party against whom enforcement is sought indicating that a contract has been made for the sale of a stated quantity of described securities at a deﬁned or stated price • delivery or transfer has occurred and the issuer does not send a wri�en objection within ten days • the party against whom endorsement is sought admits in court that a contract was made for the sale of a stated quantity of described securities 31 . A purchaser who receives a certiﬁcated security in registered form but without a necessary endorsement may become a bona ﬁde purchaser only when the endorsement is supplied. A person who transfers a certiﬁcated security to a purchaser for value warrants several things: • The transfer is eﬀective and rightful. the transfer is complete on delivery and the purchaser has an enforceable right to have the necessary endorsement supplied.Chapter One — Uniform Commercial Code • other securities if eﬀorts at their resale would be unduly burdensome or there is no readily available market for their resale When presenting a certiﬁcated security for registration of transfer. A purchaser for value and without notice of adverse claims who receives a new. payment or exchange. reissued or reregistered security warrants that he has no knowledge of any unauthorized signatures in a necessary endorsement. • He has no knowledge of a fact which might impair the validity of the security. Against the transferor. Purchaser Legal Rights Legal rights in a security transfer to the purchaser are established when: • the purchaser or his representative acquires possession of a certiﬁcated security • the transfer. a person warrants that he is entitled to that registration.
and materials used or consumed in a business 32 . A secured transaction is a transaction in which a borrower or a buyer provides security in the form of personal property to a lender or a seller that an obligation will be fulﬁlled. The UCC refers to all these security devices as security interests. including raw materials. as semi-intangible collateral (it has physical existence but is simply representative of a contractual obligation. and as purely intangible collateral (i. If the loan is not repaid. security arrangements have developed that allow the debtor to retain the physical possession and use of the property.e. family or household purposes 2. Deﬁnitions Certain terminology must be deﬁned in the area of secured transactions. the lender can sell the property to satisfy the obligation or debt. in a profession. diamond ring) to a lender as security for a loan. factors’ liens. security interest—an interest in personal property or ﬁxtures that secures payment or performance of an obligation secured party—a lender. Such security arrangements are sometimes referred to as cha�el mortgages. inventory—goods that a person holds for sale or lease and that are to be furnished under a contract of service. accounts receivable). and so forth. A pledge is o�en unsatisfactory as a security arrangement because it requires the physical possession of the property to be transferred to the creditor. Tangible Collateral 1. works-in-process. or by a non-proﬁt organization or government agency (serves as a catchall for all other goods which defy classiﬁcation) 3. consumer goods—those goods bought primarily for personal. wage assignments. conditional sales contracts. i. equipment—those goods that are used or purchased primarily for use in a business.e.. In a pledge transaction.e. The simplest type of secured transaction was historically referred to as a pledge. As a result of this inconvenience. transfers of insurance policies and artisans’ liens). in farming. a borrower gives the physical possession of his property (i. seller or other person in whose favor there is a security interest debtor—the party who owes an obligation and is providing the security collateral—the personal property in which a security interest exists Types of Collateral Collateral may be classiﬁed three ways: as tangible collateral (physical property or goods)..Certiﬁed Bank Auditor Examination Review — Volume 7 SECTION 1. negotiable instruments)..7: ARTICLE 9—SECURED TRANSACTIONS Article 9 Scope Article 9 applies to secured transactions (and excludes coverage of landlords’ liens. ﬁnished goods.
• The debtor has authenticated a security agreement or the secured party has possession of the collateral. The security agreement is required to be in writing. The agreement must be signed by the debtor and must contain a description that reasonably identiﬁes the collateral. a security agreement • instruments—negotiable instruments.) 4. A�achment is the creation of a security interest in property occurring when the debtor agrees to the security. receives value from the secured party and obtains rights in the collateral. milk. Intangible Collateral • accounts—any right to payment for goods sold or leased or for services rendered. whether or not earned by performance. supplies used or produced in farming operations. • general intangibles—goodwill.) Semi-intangible Collateral • documents of title—documents that in the regular course of business or ﬁnancing are treated as suﬃcient evidence that the person in possession of the document is entitled to receive. A security interest in inventory automatically covers a�er-acquired inventory. wool. hold and dispose of the document and the goods it covers—including bills of lading and warehouse receipts • cha�el paper—writing or writings that provide evidence of both an obligation to pay money and a security interest in or a lease of speciﬁc goods.Chapter One — Uniform Commercial Code (The primary test to be applied in the determination of whether goods are inventory is whether the goods are held primarily for immediate or ultimate sale or lease. Elements for the A�achment of a Security Interest • The debtor possesses rights in the collateral. and any other writing that evidences a right to the payment of money and is not itself a lease or security agreement. farm products—include crops and livestock. and the products of crops or livestock in their unmanufactured state (co�on. unless the arrangement is a possessory one and the secured party is in possession of the collateral. may be negotiable dra�s.) if such items are in the possession of a debtor who is engaged in farming operations (Goods cease to be farm products and therefore must be reclassiﬁed when they are no longer in the farmer’s possession or when they have been subjected to a manufacturing process. • There must be an obligation for value to be performed or given by the creditor. etc. certiﬁcates of deposit and promissory notes All of these types of paper are in writing and are representative of obligations and rights. 33 . checks. patents and copyrights The diﬀerence between intangible and semi-intangible collateral is that intangible collateral is not represented by an indispensable writing. Agreement and Attachment The creation of a valid security interest between the debtor and the secured party requires an agreement and a�achment to the collateral. securities such as stocks and bonds.
Three elements must be present for the a�achment of a security interest. The ﬁnancing statement also contains a description of the collateral. These events may occur in any sequence. a security interest must a�ach to the collateral. This is also the case with consumer goods that are given as additional security unless the consumer obtains the goods within ten days a�er the secured party gives value. taking possession of the collateral 2. A�er-acquired property is a concept involved in securities. the code places certain limitations on the eﬀect of a�er-acquired property clauses in relation to crops and to consumer goods.Certiﬁed Bank Auditor Examination Review — Volume 7 To be enforceable. the ﬁling 34 . Methods of Perfection A creditor with a perfected security interest has priority over the claims of a bankruptcy trustee. This property is referred to as a�er-acquired property. This ﬁling must occur at the appropriate public oﬃce designated for that purpose. An a�er-acquired property clause severely binds the debtor. The security agreement also may provide that certain property acquired by the debtor at any later time will become collateral. ﬁling a ﬁnancing statement 3. However it must be remembered that a ﬁnancing statement is not a substitute for the security agreement. A ﬁnancing statement is a document containing the addresses of both the debtor and the secured party. Perfection normally involves ﬁling a ﬁnancing statement (see deﬁnition below) that puts the world on notice that the secured party has a security interest in the property. a�achment of the security interest The ﬁrst and simplest method of providing notice of a security interest is for the secured party to take possession of the collateral. Value and After-Acquired Property Value means that a secured party has provided the debtor with any consideration adequate to support a simple contract. unsecured securities and certain other transferees. the debtor must possess rights in the collateral 2. No security interest can be a�ached under an a�er-acquired property clause to crops that become such more than one year a�er the execution of the security agreement. Therefore. A second method of perfection is the ﬁling of a ﬁnancing statement. there must be an agreement between the debtor and the secured party that there should be a security interest. The purpose of ﬁling a ﬁnancing statement is to provide notice that the secured party who ﬁled it may have a secured interest in the collateral. 1. Unless the ﬁnancing statement contains an expiration date of a shorter duration. the secured party must have given value 3. Methods of Perfection 1.
A security interest in certiﬁcated securities. negotiable documents or instruments is perfected without ﬁling (or taking possession for a period of 20 days) if the secured party makes available to the debtor the goods (or documents representing the goods) for the purposes of ultimate sale or exchange. The third method of perfection requires only the a�achment of the security interest without any further action being required. A�er these 20-day periods end. A perfected security interest in a certiﬁcated security or instrument remains perfected for 20 days without ﬁling if the secured party delivers the security certiﬁcate or instrument to the debtor for the purpose of ultimate sale or exchange. collection. a security interest in instruments may be perfected by ﬁling. enforcement. manufacturing. compliance with ordinary provisions of Article 9 apply. a purchase-money security interest in consumer goods 2. for loading. Perfection by a�achment limits the protection furnished to the secured party. A good-faith purchaser is one who buys the collateral and is unaware of the existence of any security interest in the property. The full list of automatic perfection situations is found in 9-309. it may be necessary for a secured party with a possessory security interest to temporarily release possession of the collateral to the debtor. or for otherwise dealing with them in a manner preliminary to their sale or exchange.Chapter One — Uniform Commercial Code is eﬀective for a ﬁve-year period from the date of ﬁling. processing. the secured party is not provided protection against the rights of a consumer or farmer who is a good-faith purchaser from the debtor. A continuation statement signed by the secured party may extend the eﬀectiveness for an additional ﬁve years. unloading. The UCC provides relief by stating that a security interest remains perfected for a period of 21 days without ﬁling where a 35 . or for presentation. Perfection With and Without Filing Under 9-312(a). However. The secured party is protected against the claims of creditors of the debtor and from others to whom the consumer or farmer debtor may give a security interest in the collateral. a sale of a promissory note. under which possession was the only method for perfection in the long term. storing. For such temporary releases. This is o�en referred to as perfection by a�achment or automatic perfection. a sale of a payment intangible 4. shipping. an assignment of accounts or payment of intangibles which does not by itself or in conjunction with other assignments transfer a signiﬁcant part of the assignor’s similar accounts 3. The code also provides for the ﬁling of a termination statement to clear the public record when the secured party is no longer entitled to a security interest. the requirement of ﬁling is too cumbersome. renewal or registration of transfer. This rule represents an important change from former provisions of Article 9. For several reasons. Situations resulting in automatic perfection: 1.
Only when the goods (or documents representing the goods) are released to the debtor for ultimate sale or exchange. The debtor may exercise certain privileges without violating the security agreement: He may collect or compromise accounts receivable or cha�el paper. The debtor also may use. the ﬁrst to be perfected will prevail regardless of the order of a�achment • If neither of the security interests is perfected. these privileges may be legally restricted by the provisions of the security agreement. regardless of the order of a�achment • Unless both interests are perfected by ﬁling. a buyer in the ordinary course of business will take the property free of security interests created by the seller in the seller’s inventory. A secured party who has not perfected his security interest has a very limited protection against third parties. the ﬁrst to ﬁle will prevail. A secured party who has a possessory security interest is required to exercise reasonable care of the collateral. all reasonable expenses related to the collateral are the responsibility of the debtor and are secured by the collateral. The burden of accidental loss or damage is placed on the debtor except for the amount covered by insurance. Creditors must comply carefully with the statutes if the desired protection is to be obtained. The secured party may also repledge the collateral (use the collateral as security in his own ﬁnancing). This provision applies to instruments. provided the repledge does not impair the debtor’s right to redemption. or to make an ultimate sale or exchange. to obtain registration of a transfer. collect or renew the instrument. the purpose must be to allow the debtor to present. and he may accept the return of goods or make repossessions. Unless the security agreement speciﬁes otherwise. In the situation of a temporary release of an instrument to the debtor. Priority The following priority rules apply for perfection in a variety of situations. shipping and manufacturing. priority will be given to the ﬁrst party to a�ach • When perfection is by possession. the secured party is protected against all third parties as long as possession is maintained Rights and Duties The secured party has certain rights and duties in a secured transaction. An unperfected security interest will have priority over third parties who acquire the property with prior knowledge. negotiable documents and goods in the hands of a bailee that are not covered by a negotiable document of title. for purposes such as storing. These rights and duties are those established in the security agreement and those provided by the Code. or for some other similar purpose will this provision apply. 36 . However. • If the conﬂicting interests are perfected by ﬁling. However.Certiﬁed Bank Auditor Examination Review — Volume 7 secured party having a perfected security interest releases the collateral to the debtor. commingle or dispose of the proceeds.
manner. however. This is to foster the Code’s policy to encourage private dispositions through regular commercial channels. cha�el paper. Remember. Such action may not be deemed commercially reasonable. This version of Article 9 speciﬁes no time period for the disposition of collateral. by one or more contracts. the code provides that the secured party may collect any amounts that become due on the collateral. If commercially reasonable. license or otherwise dispose of any or all of the collateral in its present condition or following any commercially reasonable preparation or processing. The remedies available to the secured party are established by the terms of the security agreement and by the provisions contained in the code. 37 . place and other terms. that every aspect of the disposition must be reasonable and so an indeﬁnite retention of the collateral where there is no good reason for such retention may be viewed unfavorably. The secured party may take possession of the property without judicial process provided he can do so without breaching the peace. as a unit or in parcels. The basic remedy for the secured party is to repossess the collateral and dispose of it. time. If the collateral is accounts. and at any time and place and on any terms.Chapter One — Uniform Commercial Code Remedies The debtor defaults under the security agreement when he fails to satisfy or pay the obligation that is secured or when he otherwise breaches the security agreement. a secured party may sell. including the method. Disposition Under 9-610. Every aspect of a disposition of collateral. The secured party may also retain the collateral as satisfaction of the debt and not sell it. a secured party may dispose of collateral by public or private proceedings. lease. a�er a default. must be commercially reasonable. instruments or general intangibles.
4. T F The provisions of the UCC govern the terms of relevant agreements and may not be varied in any way by agreement of the contracting parties. 3. growing crops and standing timber. T F The primary purpose of the UCC was to collect all aspects of commercial transactions into one body of law.Certiﬁed Bank Auditor Examination Review — Volume 7 Practice Challenge Questions Directions: Circle T if the answer is true. T F An issuer is free to dishonor a draft or demand for payment which meets all of its terms or conditions. A borrower has a debtor-creditor relationship with the bank. T F Duly authorized acts by an agent will bind the principal. 10. 2. 5. 38 . 8. and (2) it is payable on the occurrence of an uncertain event. T F Quantity is the only term that. 9. T F The characteristics of a non-negotiable instrument are (1) it is not payable to order or bearer. T F A letter of credit may function as a medium of payment or as a back up against customer default on ﬁnancial or other obligations. T F The beginning of the collection process is the writing of a check by a customer. T F Commercial paper consists of two basic types of instruments: drafts and bearer bonds. if completely omitted. or F if the answer is false. T F Goods include the unborn young of animals. cannot be supplemented by the provisions of Article 2. 1. An agent will also be liable if he fails to exhibit his representative capacity. 6. T F A bank and its depositors have a legal relationship of debtor and creditor. 12. 11. An agent who fails to name his principal or who lacks the authority to bind his principal will be liable to third parties. T F It is always true that the title acquired by a purchaser of goods is only as good as the title of the transferor. 7.
16. T F A security interest is an interest in personal property or ﬁxtures which secures payment or performance of an obligation.Chapter One — Uniform Commercial Code 13. T F Perfection by attachment requires that the issuer of a security ﬁle with state authorities within 10 days. 15. T F A term may be made conspicuous by printing a heading in capital letter or printing language in the body of a form in a larger or contrasting type or color. 39 . 14. T F A contract for the sale of securities is enforceable if there is a writing signed by the party against whom enforcement is sought indicating that a contract has been made for the sale of a stated quantity of described securities at a deﬁned or stated price. T F The purpose of ﬁling a ﬁnancing statement is to provide notice that the secured party who ﬁled it may have a secured interest in the collateral. 17.
pre-approved 5. notation of the issuer’s right to the lien c. good faith and observance of any general banking usage 2. breach the peace and take other unrelated items to satisfy the debt 40 . a secured party may _____ _____ as a remedy against a debtor who fails to pay or satisfy his obligation. legally permissible d. appropriate c. license or otherwise dispose of any or all of the collateral in its present condition or following any _____ preparation or processing. a secured party may sell. repossess the collateral and dispose of it c. An issuer’s lien is_____. a. 1. a. In a typical situation. receipt b. a lien where the issuer is forced to accept a partial interest in the security. what are the two obligations an issuer has to its customer? a. If the security is uncertiﬁcated. a lien where the issuer need not note his right to the lien in any way 4. Under 9-610. standards of the uniform banking act and SEC ﬁlings d. a lien in which the issuer is granted double recovery rights in the event of a default c. Under Article 5. charge a double fee to the debtor and report him d. but cannot seek legal recourse d. a _____ must be included in the initial transaction statement sent to the purchaser. commercially reasonable b. a. a certiﬁcated security on which the issuer’s right to the lien is conspicuously noted b. copy of the terms and conditions d. good faith and common sense c. copy of the articles of incorporation 3. lease. adversely possess the collateral and sell it back b. a. after a default. general commercial reasonableness and general banking usage b.Certiﬁed Bank Auditor Examination Review — Volume 7 Directions: Circle the letter of the answer that most accurately completes the sentence.
reasonable c. scrap 9. negligibly impairs 10. the buyer has the right to _____ the goods at a reasonable time and place and in any reasonable manner. the party has reason to know the fact. Where this is not possible. course of dealing and usage of trade should be interpreted as consistent with each other where _____. express terms. a.Chapter One — Uniform Commercial Code 6. When interpreting a contract. Revocation can occur only if the non-conformity “_______ the value to the buyer.. completely impairs b. a. negotiated c. qualiﬁed 41 . commercial d. actual knowledge b. destroy c. the express terms control both course of dealing and usage of trade. unreasonable d. restrictive b. a strong suspicion d. may be disregarded by an intermediary or payor bank that is not a depository bank. constructive knowledge c. a. seize b. The UCC permits notice of a fact when a party has (1) ______(2) received notice or notiﬁcation of the fact.” A buyer who revokes acceptance is placed in the same position relative to the goods as if he had rejected them in the ﬁrst place. Before payment or acceptance of goods. a. substantially impairs c. a. heard a rumor 7. inspect d. commercially prudent 8. logical b. The UCC provides that any _____ endorsement. partially impairs d. except that of the bank’s immediate transferor. or (3) from all the facts and circumstances known to the person at the time in question.
then the item becomes ﬁnal on the opening of the _____ banking day following receipt of the item. 2. second c. What are the common methods for breaching a contract? 42 . third d. If a check drawn by a customer of a bank is deposited by another customer of the same bank (i. the depository bank is the payor bank). List the different types of warranties supplied by Article 2. insanity b. In a contract action. 1.e. List the four requirements of a negotiable instrument. 4. real c.. a. personal 12. a. Explain the essential elements for a sales contract. a(n) _____ defense is an ordinary defense that the maker or drawer of a negotiable instrument is precluded from raising against a person who has the rights of a holder in due course. limited d. fourth Write complete and thoughtful answers to the following questions. Deﬁne commercial paper and explain its uses. and brieﬂy explain their signiﬁcance. ﬁrst b.Certiﬁed Bank Auditor Examination Review — Volume 7 11. 5. 3.
Deﬁne secured transaction. Deﬁne letter of credit below: 10. 43 . 12. Deﬁne protest. 9. list three of the rules that apply in an action brought against the issuer of a security to enforce a right or interest that is part of a security. What is a Holder in Due Course? 8. 7. 13.Chapter One — Uniform Commercial Code 6. List and describe the various types of letters of credit 11. In the space provided below. List the items that a seller of an investment security may recover if the buyer does not pay the sale contract price. Deﬁne depository bank.
15. family or household use.Certiﬁed Bank Auditor Examination Review — Volume 7 14. Matching Read the directions for each matching exercise. Used in the regular course of business or ﬁnancing and treated as evidence that the possessor is entitled to the goods 44 . Deﬁne the term secured party. negotiable collateral that evidences a right to the payment of money and is not itself a lease or security agreement. Collateral bought primarily for personal. Document of title _____ 4. e. Instruments _____ a. d. Consumer goods service _____ 2. Chattel paper _____ 5. Inventory _____ 3. Below is a list of collateral terms and collateral descriptions. Match the letter and the deﬁnition to the correct term by placing the letter in the space provided. Collateral that a person holds for sale or lease and that are to be furnished under a contract of service b. 1. Terms Description 1. List the three elements for the attachment of a security interest. Collateral that provides evidence of an obligation to pay money and a security interest in or a lease of speciﬁc goods c.
_____ reject the contract c._____ cancel the contract e._____ sue for the actual price of goods b._____ sue to get the goods 3. and buyer by placing a “B” in the blank. _____ examine cancelled checks d. and indicate which items are responsibilities of customers by putting a “C” in the blank._____ recover damages for non-acceptance f. Please indicate if the particular remedy is for a seller or a buyer._____ cover and recover damages d. _____ honor stop payments 45 . a. From the list below. _____ examine bank statements b._____ recover damages for non-delivery h.Chapter One — Uniform Commercial Code 2._____ resell the goods and recover damages g. _____ honor checks c. a. Indicate seller by placing an “S” in the blank. indicate which items are the responsibilities of banks in the bank collection and deposit process by placing a “B” in the blank.
you will be able to: • describe the validity requirements for a will and changes to a will • describe the roles and responsibilities of each of the parties involved in a will or trust • explain the overall estate administration process • identify cases in which a will or trust is ﬁxed and irrevocable as well as situations in which a will or trust can be modiﬁed or revoked • describe the three diﬀerent types of property ownership • identify personal.2 2.3 2.1 2. which makes up 30 to 40% of Part 4 of the CBA exam.5 2.7 2. which makes up 25 to 35% of Part 4 of the CBA exam Chapter Topics The following topics are covered in this chapter: 2.Chapter Two — General Commercial Law Chapter Two General Commercial Law Scope: Volume 7 constitutes Business Law. Volume 9 addresses Management Issues. which make up 15 to 25% of Part 4 of the CBA exam. business or property relationships which permit a person to take out an insurance policy • describe the diﬀerent types of insurance • identify typical insurance policy clauses and limitations • understand the insurance company’s legal rights to recover from those who cause a loss • identify circumstances concerning a voided policy or a lapsed policy • comprehend the relationship between parties in a guaranty/surety agreement and diﬀerent types of agreements • describe the guarantor’s rights and responsibilities • identify defenses that a guarantor can use to defeat a creditor’s claims • identify the diﬀerent kinds of partnerships and contents of agreements • identify the rights. Volume 8 makes up Economics. estates.4 2. and trusts Insurance Guaranty and suretyship Partnerships Agency Contracts Bankruptcy Antitrust Chapter Objectives A�er completing this chapter. duties and powers of partners 47 .8 Wills.6 2.
• community property—Community property states have statutes in which property rights of married people are subject to special rules. which have particular implications upon death or divorce.1: WILLS. In other cases. • guardian—The personal representative of a living person who is a ward (generally a child) is referred to as a guardian.Certiﬁed Bank Auditor Examination Review — Volume 7 • describe the steps in extinguishing a partnership: dissolution. • se�lor or trustor—An individual who makes a trust is commonly referred to as a se�lor or a trustor. use and disposition of property of the individual who makes the trust—trusts can function before and a�er the death of the maker. the provisions for future transfer of property from one party to another are completely ﬁxed and nonrevocable. the future transfer of property is dependent on contingencies and therefore could be delayed or even canceled. In some cases. ESTATES AND TRUSTS Scope As parties manage their ﬁnancial aﬀairs. • intestate—An individual who dies without a will is said to have died intestate. • administrator/administratrix—The personal representative of an individual who dies intestate is called an administrator/administratrix. winding-up and termination. • trust—A trust directs the management. Wills and trusts are used to direct a party’s property to other people upon certain events—most commonly the death of the party making the will or trust. Estates and Trusts—Deﬁnitions • will—A will directs the disposition of an individual’s property upon his death. • executor/executrix—The personal representative of a testator is called an executor/ executrix. • conservator—The personal representative of a living but mentally incompetent person is a conservator. • testator/testatrix—An individual who makes a will is commonly referred to as a testator/ testatrix. they make provisions for the future nonsale transfer of their property to others. Wills. • identify the diﬀerent kinds of agents and principals and related duties • describe agent’s authorities and liabilities • identify tort liabilities and the liabilities of disclosed and undisclosed principals • explain the termination of an agency relationship • identify diﬀerent types of contracts and the four required elements of a valid contract • identify the circumstances under which a contract can be voided or breached • describe the roles of third parties in an existing contract • identify diﬀerent chapters or types of bankruptcy proceedings • identify property and debts that are exempted in bankruptcy • describe the role of the bankruptcy trustee and his duties and powers • explain the prioritization and payment (or discharge) of creditor’s claims • identify diﬀerent acts that have been passed by Congress in the area of antitrust SECTION 2. 48 .
and it shall be enforced as originally executed. state laws generally prohibit partial revocation of a will except by a duly signed and a�ested instrument. creating a will that revokes a prior one. deletions and interlineations on the face of the will are. Substitutions. In most states. Note: A credible witness is one who is competent to testify to support the will. additions. Note: This includes a minimum age requirement and the minimum capacity to understand the nature and the plan involved in creating the will. 49 . In several states. divorce only revokes the will to the extent of bequests or devises to the former spouse. upon a marriage or divorce. but it must be executed in the same manner as a new will. some generalities do exist. therefore. Wills Executing a Will A will is a document that signiﬁes an individual’s intention concerning disposition of his property on death. alterations. making a later will inconsistent with a prior one. marriage and divorce. Another option is through a wri�en instrument declaring the revival. Note: Oral wills are not recognized in many states.e. however. This also includes the absence of undue inﬂuence. Therefore. state law be consulted concerning the eﬀect on the testator’s prior will. • It must be a�ested in the presence of the testator by two or more credible witnesses. a will that is totally revoked by any method can be revived only by the re-execution of the will. The will also may designate the deceased’s personal representative and may make provisions for the payment of taxes. (deﬁned as inﬂuence that overpowers the mind of the testator and deprives him of his free agency in the execution of his will). Revocation of a Will Wills may be revoked by several methods. Finally. The legal requirements for a valid will vary from state to state. An otherwise properly executed will may be challenged on the grounds noted above as well as other more technical grounds. it is imperative that.Chapter Two — General Commercial Law • trustee—The individual who manages the property in the trust is called a trustee. For a will to be deemed valid: • It must have been executed by a person possessing testamentary capacity. A witness is not allowed to proﬁt on—or gain from—any property as a result of the will. who receives property under the will) is not allowed to receive more property as a result of the will than he would receive if no will existed. In most states an individual who is an interested party (i.. • beneﬁciaries—The individuals who use or receive the property in the trust are called beneﬁciaries. • It must be signed either by the testator or by someone in his presence and at his direction. Among the prevalent methods of revocation are physical destruction of the will. ineﬀective.
This is commonly called the Widow’s Right of Election. The executor or administrator then collects all of the deceased’s personal property. The personal representative must also a�empt to collect all outstanding receivables of the deceased. In these states. the executor must follow its direction. evidence is requested by the court and normally supplied by the a�esting witness as to the proper execution of the will. the laws of that state may aﬀect the deceased’s property ownership rights and could restrict or even prohibit the transfer the property. At the hearing. A�er the appointment of the executor or administrator. If the deceased had a valid will. If the deceased died intestate. the representative can then distribute the remaining property. If an individual dies intestate. It is important for the executor of an estate to know if the deceased ever lived in a community property state because this could aﬀect the distribution of property. Also. In community property states. public notice of the death must be provided to his creditors through public newspapers. The executor or administrator then ﬁles an oath of oﬃce and an appropriate bond to guarantee the faithful discharge of the duties of personal representative. then the court itself can appoint the administrator. If no will exists and the individual entitled to administer the will so requests. and an executor (chosen by the testator) is appointed. If there is a chance that someone is going to contest the will. In this case. Even if the deceased did not live in a community property state at the time of death. The right to support during the administration of the will is one of these rights. State law generally provides a spouse certain rights that cannot be denied by a will. If the court deems that the will was properly executed. it is usually happens at this point in the process. takes inventory and ﬁles the inventory listing with the court. if any. Administering the Estate: Distributing the property During the administration period. a majority of state laws allow the spouse to renounce a will and to take a statutory share in lieu of its provisions. the court determines who are the legal heirs as of the date of death and the administrator of the estate distributes the property accordingly. community property law may still apply to real estate located in that state. The court then sets a date for a hearing at which time the will may be presented for probate. A�er the payment of all outstanding debts and taxes. the laws regarding spousal property rights can actually override and therefore change a will’s distribution of property. A petition informing the court of the death of the deceased and appending a copy of the will (if there is one) is normally required to be ﬁled. the executor or administrator must ﬁle all required tax forms. the petition should be signed by someone entitled under the laws to serve as administrator of the estate. these heirs are the deceased’s spouse and children. All interested parties are entitled to notice of the time and place of the hearing.Certiﬁed Bank Auditor Examination Review — Volume 7 Estates Settling an Estate The statutes of the individual states determine the steps to be taken by the executor or administrator in the se�lement of an estate. one’s 50 . it is then admi�ed to probate. In most states.
Joint Tenancy For two or more parties to establish valid joint tenancy of property. or a transfer by one spouse to the other. 2. 4. his share of the property passes to his estate and is distributed by either the executor of the will or the administrator of the estate. This is depicted below. joint transfer to a third party. 3. the law requires: 1. Tenancy by the entirety applies only to real estate held by spouses.Chapter Two — General Commercial Law spouse can never be completely disinherited. A residuary gi� is a gi� that includes all the personal property that is not included in the speciﬁc or general bequests or devises. Devises and bequests are further subdivided into speciﬁc. unity of time—The joint tenants’ ownership must be created at the same time. Speciﬁc legacy “my home at 123 Fake Street…” General legacy “one half of my coin collection…” Residuary gift “one quarter of my estate…” 51 Devises and Bequests . Tenancy in Common If a party to a tenancy in common dies. Some states have modiﬁed these methods. joint tenancy and tenancy by the entirety. A gi� of particular property so identiﬁed as to distinguish it from other property is a speciﬁc legacy or speciﬁc devise. unity of interest—Each owner must have equal shares of the property. A bequest is a gi� by will of personal property. title passes to the survivor free of the claims of anyone else except for any taxes due and does not pass through the estate administration process. The ﬁrst two methods are applicable to both real and personal property. unity of title—The joint tenants must have the same estate created in the same manner. general and residuary. Tenancy by the entirety can be terminated only by divorce. Devises and Bequests of Property A devise is a gi� by will of real estate. With joint tenancy. Property Ownership Rights The three methods by which two or more people may own property together are tenancy in common. so each state’s law should be consulted. If a party to property held in joint tenancy dies. unity of possession—Each owner has the right to possess all of the real estate subject to the owner’s rights of possession. Tenancy by the Entirety Tenancy by the entirety can exist only between a husband and wife with regards to real estate. the deceased party’s interest automatically passes to the surviving joint owner(s). A general legacy may be satisﬁed by the delivery of any property of the general type described.
But she also wants the property to be eventually split by both sons. the trustee and the beneﬁciary at the same time. In this way. This is then coupled with a later transfer of the property title. however Be�y can’t use the trust property for her own good. resulting trust and constructive trust. The trustee possesses the title to the property and manages the property for the beneﬁt of another person referred to as the beneﬁciary. This allows a trust beneﬁciary to use and/or collect income from the property for a period of time while the property title stays in the trust. Ben (who is an adult) and Charlie (who is an infant). the title to the property itself transfers to Ben and Charlie and the trust is terminated. Any property that has the capacity to be transferred may be held in trust. Charlie. Abby puts all her property into a trust. However when used alone the term trust generally refers to an express private trust. Once the trust is eﬀective. The trustee is under an absolute obligation to act solely for the good of the beneﬁciary. For example.. Charlie. When Charlie reaches a certain age (as set by Abby in the trust documents). A�er the period of usage is over the property title is assigned to the designated trust beneﬁciary (either the same or a diﬀerent beneﬁciary). The individual who creates the trust is referred to as the se�lor. Abby can use her property as she likes and take the income from the property as well. Income from the trust property goes to Abby’s son. her best friend Be�y becomes the trustee. Abby is the se�lor. Charitable Trusts A charitable trust is a trust that can beneﬁt an indeﬁnite group and can have perpetual 52 . Anticipating her eventual death. Abby owns property which produces an income.Certiﬁed Bank Auditor Examination Review — Volume 7 Trusts Types of Trusts The law recognizes four types of trusts: express private trust. The trust property stays in the trust under Be�y’s management.e. The se�lor’s intention to create a trust must be clear. Abby dies and. Property transfer is immediate and the beneﬁciary gets ﬁnal complete legal title to the property (i. At this point. Express Private Trusts An express private trust is a ﬁduciary relationship with respect to property. so he is cared for while he’s a minor. A trust involving real estate must be in writing. charitable trust. a trust may have more than one beneﬁciary and may provide for successive trustees or beneﬁciaries.) On the other hand. She has two sons. property transfer can be a trust-deﬁned period of usage. pursuant to her trust documents. This makes Charlie the beneﬁciary. the beneﬁciary as deﬁned in the trust document. the person having legal title to the property is the trustee. she wants to provide for her young son. There are two types of express private trusts: an inter vivos or living trust—a trust created by a transfer of property during one’s lifetime—and a testamentary trust—a trust that transfers property on one’s death. Because she is the beneﬁciary herself. In this case. creator or trustor.
there are some exceptional circumstances in which a trust can be terminated. • The trustee possesses all the necessary powers to perform the duties of a trustee. the court can carry out the general charitable intention by prescribing the application of the trust property to another charitable purpose consistent with the original. a trust may be terminated. the trustee is under an absolute obligation to act solely for the good of the beneﬁciary. The trustee has powers to do as he sees ﬁt. However. • When its purposes have been accomplished. to se�le claims and to retain investments. Resulting and Constructive Trusts Resulting trusts and constructive trusts are created by operation of law. and not for his own good or purposes. However. Termination of a Trust Once a trust is in eﬀect. to lease. The trustee must segregate trust property and may not commingle trust property with his own property. These powers include the power to sell. a resulting trust is created by a court of equity. the trustee must exercise the judgment of a prudent man (using the prudent man rule). The doctrine of cy pres (as nearly as) provides that if a particular charitable purpose cannot be fulﬁlled in the manner directed by the se�lor. In the area of investment selection.Chapter Two — General Commercial Law existence. Duties of the Trustee The most important thing to remember with regards to the duties of the trustee is that a breach of these duties creates liability to the trust beneﬁciaries. The trustee possesses the title to the property and manages the property for the beneﬁt of the beneﬁciary. to incur necessary expenses. This requires that complete determination of property distribution to all beneﬁciaries has been ﬁnalized and is ﬁxed. However. it typically cannot be revoked. diversiﬁcation and appropriateness. • If the purpose of the trust becomes illegal. then the trust cannot be terminated. a trustee is liable to the trust beneﬁciaries for any losses due to a breach of trust or for any personal proﬁt made due to a breach of his ﬁduciary responsibilities. Typical charitable trusts provide funds for religious groups or for educational and health purposes. When the party with legal title to property is not intended to have it. If the trust contains any language which makes the property distribution contingent on an event which hasn’t yet occurred. A constructive trust is created by a court of equity for the purpose of preventing unjust enrichment as in the case where a transfer of property is obtained by fraud or violation of some ﬁduciary duty. Therefore. The trustee is also responsible for reviewing assets for quality. a trust may be terminated 53 . the trustee does not generally have the power to borrow money or to mortgage the trust assets. changed or terminated except as provided for in the trust document that created the trust. • The trustee also has a duty to diversify investments of the trust fund. • If it can be proven that the se�lor was defrauded or mistaken then he may be allowed to revoke the trust. Rules for a Trustee • The trustee may not delegate his responsibility to another person.
the insurer.2: INSURANCE Introduction Insurance is a way to anticipate risks that would cause signiﬁcant losses and to provide for compensation upon the risks’ occurrence. against risks of loss on speciﬁed property. Insurance distributes the cost of risk over a large number of individuals who are subject to the same risks so that those who actually suﬀer a loss may be reimbursed. Other ways to self-insure are book reserves. General Terms: • owner—the party who took out the policy and makes the payments • insured—the person whose life is being insured or the property that is being insured • beneﬁciary—the party who receives payment of the proceeds from the insurance policy • insurer—the party who contracts with the policy owner. 54 . which provides protection against the risk of loss arising from events over which the insured has li�le control. In this way. Insurance is a contract whereby one party. by speciﬁed risks or perils.Certiﬁed Bank Auditor Examination Review — Volume 7 • In some states it is possible for a trust to be terminated by the consent of all beneﬁciaries provided that all are of legal age and that the termination will not defeat the purpose for which the trust was created. i. etc. Some states frequently require clear language within the trust before they will permit termination by beneﬁciaries. he can recover assets to partially or totally oﬀset the loss. The insured pays the insurer a stipulated consideration called a premium for this coverage. sometimes a party will choose to self-insure. the bank’s risk can be reduced or eliminated if the bank requires that the individual insures against speciﬁc risks and makes the bank the irrevocable beneﬁciary of the policy proceeds. commits to compensate the other party. When an individual insures against a particular type of loss. the party who will pay for the loss • event—the risk or peril which occurs and which results in loss Note: Self-Insurance Compared to Insurance Rather than pay premiums for a policy from an outside insurance company.e. for example. the insured. In bank transactions with an individual. chronological stabilization plans and use of a captive insurance company. since it is only the advance ﬁnancial preparation for possible losses and not a distribution of risk. The disadvantages of self-insurance are both shortfalls due to incurring losses before a suﬃcient reserve is built up and overpayment from incurring losses greater than the cost of regular insurance premiums. There are numerous types of self-insurance. Self-insurance is not true insurance.. SECTION 2. One approach is the periodic se�ing aside of money into a fund to cover possible losses. The advantage of self-insurance is the possible savings if losses are small or nonexistent. an individual can be assured that even if the risk occurs and does cause a signiﬁcant loss. Other states require clear language speciﬁcally prohibiting the trust’s termination before they will block termination. he can name himself or other parties as beneﬁciary.
term life insurance. Therefore. Note: Life insurance or property insurance which is wri�en without any insurable interest is considered a wager and the policy will not be valid. the insured and the event—this is called an insurable interest. This prevents an unaﬃliated person from simply be�ing that some other person will die or that the other person’s property will be destroyed. The exception is that a parent does not have an automatic insurable interest in a child that has reached the age of majority. To have an insurable interest in property (such as ﬁre insurance) the policy owner must have a legal interest in the insured property and a possibility of monetary loss. That is. ordinary life (whole life) insurance. There are two types of interest in life insurance. limited payment life insurance. A legal interest may exist by owning the property or having an interest in the property such as a mortgage or a lease. automobile insurance. • Interest in one’s own life: An insurable interest always exists in one’s own life. An insurable interest may also be created by business relationships. Life Insurance With life insurance. everyone has an insurable interest in his own life. but is not necessary when the loss occurs. a beneﬁciary does not need an insurable interest. This insurable interest must exist when the policy is taken out. liability insurance. there must be a relationship so that the person taking out the insurance (the policy owner) has a legal right to the monetary loss upon the death of the insured. An individual with a contract to purchase property or in possession of property may have an insurable interest. malpractice insurance. Types of Insurance Life insurance. endowment policy. It also removes any ﬁnancial incentive for criminal actions which could threaten the lives and property of others. ﬁdelity insurance. but must be present at the time of the loss. The insurable interest is not required at the inception of the policy. The insured’s consent to have his life insured is frequently required. A creditor has an insurable interest in the 55 .Chapter Two — General Commercial Law Insurable Interests Insurance compensates for substantial loss which the insured would directly suﬀer from an event. but it is typically capped by the value of the business relationship. accident insurance. An individual can insure only to the extent that he has an insurable interest. thus may insure his own life and may name anyone as beneﬁciary. ﬁre insurance and valued/unvalued policy are some examples of types of insurance available. Therefore there must be a relationship between the policy owner. Some states require veriﬁcation of a pecuniary link between the parties when insuring the life of a more remote family member such as an aunt or uncle (this is called economic expectancy). • Interest in another person’s life: An insurable interest in another person’s life is automatically created by marriage and close blood relationships—so a person may validly insure his spouse’s life or his minor child’s life.
The insured’s consent to have his life insured is frequently required. but only to the extent of his share of the partnership.Certiﬁed Bank Auditor Examination Review — Volume 7 life of a debtor. A predetermined amount is paid to either the insured’s beneﬁciary upon the insured’s death during these years or to the insured himself at the end of this period. it has no cash or loan value. Other Types of Insurance • accident insurance—Accident insurance provides coverage against expense. lawyers and other professionals. Some states have no-fault insurance which means that each owner’s insurance pays his expenses regardless of fault. Legal action is not permi�ed unless property damage and personal injury exceed a ﬁxed threshold. Intentional wrongs. but only to the extent of the debt. A partnership typically has an insurable interest in a partner’s life. • limited payment life insurance—Limited payment life insurance requires the payment of premiums over a ﬁxed number of years. An employer may have an insurable interest in a key employee. A ﬁxed sum is then paid to the beneﬁciary on the insured’s death. such as fraud. and the policyholder is insured for life. the�. • malpractice insurance—Malpractice insurance is a form of personal liability insurance used by doctors. • ordinary life or whole life insurance—Ordinary life or whole life insurance requires the insured to pay premiums over his life. Malpractice insurance protects against liability for harm caused by errors or negligence in performing work. With liability insurance the insurer has no right against the insured for causing the loss. Some whole life insurers pay dividends to the insured during the life of the policy. water or chemicals. because the insurance is purchased to protect against the loss. plus damage and personal injury caused to others. • automobile insurance—Automobile insurance indemniﬁes against loss or damage to an automobile from collision. Types of Life Insurance • term life insurance—Term life insurance covers the insured for a ﬁxed number of years. Term life insurance does not have a savings feature. therefore. windstorm and ﬁre. Most collision insurance has a deductible amount which the insured must pay. the beneﬁciary is not liable for the loan. Whole life policies accumulate earnings which increase over the life of the policy. A policy’s cash value can also be used as collateral for loans. Fire insurance covers hostile ﬁres but not 56 . are not included in this coverage. the insured is required to pay premiums for a certain number of years. If the insured dies within that term. • ﬁre insurance—Fire insurance covers direct ﬁre damage plus any indirect ﬁre damage such as damage from smoke. • ﬁdelity or guaranty insurance—Fidelity or guaranty insurance insures against loss from dishonesty of employees or people in positions of trust. etc. If a loan is outstanding at the time of the insured’s death. suﬀering and loss of earnings resulting from personal injury or property damage. These earnings are called cash value and will be paid to the insured if the policy is surrendered. It is typically less expensive than other types of life insurance and may be renewable at the end of each term. The premiums for limited payment life insurance are higher than for an ordinary life policy. but does not protect against intentional wrongs. The beneﬁciary will receive the face value of the policy less the loan and interest. then the life insurance policy pays. • liability insurance—Liability insurance protects the insured against liability for accidental damage to people or property and typically includes the duty to defend the insured in a lawsuit brought by third parties. • endowment policy—With an endowment policy.
four types of clauses exist: 1. Insurance typically becomes binding at the time of the insurer’s unconditional acceptance of the application and communication of this to the policy owner. Voiding a Policy The insurer may void the policy if there is: 1. rather than a speciﬁc piece of property. the insured recovers the fair market value of the destroyed property. the insurer is obligated between the time of application and issuance of the policy. Types of Clauses in an Insurance Contract Basically. any ma�er speciﬁcally asked by the insurer is automatically considered material. A valued policy pays face value for a total loss and actual damages for partial destruction. concealment—If the owner/insured failed to inform the insurer at the time of application of a fact material to the insurer’s risk that is concealment. A blanket ﬁre insurance policy covers a class of property which may be changing. The Insurance Contract An insurance contract is similar to a common law contract in that it requires an agreement. incontestability clause—An incontestability clause means that a�er a certain period of time. The issuance of the policy (from the insurer to the owner) is the acceptance. In many states. Some exceptions to this are nonpayment of premiums. no proof of death or the risk is not covered by the policy. the value of the property is determined at the time of the loss. legality. 2. 57 . If a company agent issues a temporary binding slip. 3. the value of the property is predetermined and becomes the face value of the policy. The owner/insured is not required to disclose facts learned a�er making the contract. Friendly ﬁres include damage caused by smoke from a ﬁre in a ﬁreplace. breach of warranty—A warranty is a representation incorporated into the policy. With an unvalued policy. capacity and consideration. material misrepresentation by insured—If a representation is substantially true. then it is acceptable. • unvalued policy—With an unvalued policy (open policy). The insurer may require that certain conditions be met before the policy becomes eﬀective. • valued policy—With a valued policy. such as inventory.Chapter Two — General Commercial Law damage from a friendly ﬁre. no insurable interest. Hostile ﬁres are unintentional ﬁres or ﬁres that have le� the intended burning spot. The application (from the policy owner) is the oﬀer. An unvalued policy does have a stipulated maximum amount. typically two years. failure to disclose or a misleading answer is concealment. It constitutes a condition that must exist before the insurer is liable and is typically assumed to be material. Therefore. a policy cannot be contested because of concealment or misstatements. Most insurance contracts are a unilateral contract where the insured prepays the premiums and the insurer promises to indemnify the insured against loss.
000/$32. Negligence on the part of the insured’s employees is also covered. some states will not allow the beneﬁciary’s creditors to reach the proceeds. Most policies have a grace period which allows premiums to be paid within a certain period a�er payment is due without the policy lapsing.000 B $20. coinsurance clause—A coinsurance clause requires the owner/insured to bear a certain percentage of the loss when he fails to carry complete coverage. i. On the other hand. This statement must be completed within a certain speciﬁed period. which is (($12. However. if the beneﬁciary is the insured’s spouse. Limitations to Coverage Coverage limitations typically include intentional acts on the part of the owner/insured.Certiﬁed Bank Auditor Examination Review — Volume 7 2. Reported loss is $15. A�er the time period expires. and Company B is liable for $9.000) x $15.375. The amount of recovery from the insurer can be calculated as follows: Formula recover = Actual loss x Amount of insurance Coinsurance % x FMV of property where FMV = fair market value 4. Failure to comply with the time requirement will excuse the insurer’s liability unless performance is made impracticable.000/$32. Other Contract Conditions In order for the beneﬁciary to collect.. pro rata clause—A pro rata clause allows a person insured by multiple policies to collect only a proportionate amount of the loss from each insurer. suicide is covered. The policy cash value and policy proceeds cannot be a�ached by the policy owner’s creditors if the policy’s beneﬁciary is named irrevocably. In some cases. For example: Company Amount of Coverage A $12. Company A is liable for $5.000 Therefore. 58 . some policies have a reinstatement provision which allows it to be reinstated within a certain period if the overdue premiums and interest are paid. etc.e. the policy owner’s creditors can a�ach the policy proceeds. total coverage on the property is $32. if the named beneﬁciary is revocable. which is (($20. 60 days.000. Even if the policy does lapse.000) of the loss. suicide clause—A suicide clause means that the policy will not cover the insured’s suicide for a certain period of time.000) of the loss. his and/or the beneﬁciary’s creditors could even force the policy to be cashed out for its cash surrender value. In some states they cannot even be a�ached by the beneﬁciary’s creditors. 3. Negligence or carelessness on the part of the insured is insurable and is generally not a defense for the insurer. if the policy owner is in bankruptcy. Typically this time period coincides with the one used in the incontestability clause.000) x $15.625. cause of loss.000. the owner/insured must give the insurer a timely statement of the amount of loss.
A right of subrogation exists with accident. 59 . Otherwise. The property could be sold to someone who is not reliable. and the responsibility of making premium payments over to the new owner (the assignee). no right of subrogation exists with life insurance policies. However. he would collect the policy’s proceeds and the insurance company could then sue Edgar in Dan’s place to recover for the loss. Subrogation gives the insurer the right to step into the shoes of the owner/insured as to any cause of action against a third party whose conduct caused the loss. Policy Assignment Since life insurance policies are considered in the nature of an investment. Assignment transfers the policy’s cash value. policy proceeds from a claim against an insurer may be assigned. Dan can’t collect the policy proceeds. For example: Dan owns a home and Edgar.Chapter Two — General Commercial Law Termination Conditions A life insurance policy may be terminated on expiration of a term policy. his careless neighbor. causes the home to burn. Life insurance policies may be assigned by the owner (the assignor). In the case of an irrevocable beneﬁciary. they can be assigned. the ability to change beneﬁciaries. Subrogation The rights of an insurance company to assume the injured party’s legal claims against third parties is called subrogation. If an individual misstates his age either the premiums or the beneﬁts will be adjusted accordingly. Dan could sue Edgar to recover for the loss. and ﬁre insurance policies. However. This is called subrogation. subrogation prevents the owner/insured from relinquishing his valid legal claim against third parties without the permission of the insurer. once a life insurance policy is assigned. the owner’s failure to pay premiums. In other words. Note: Proceeds from an in-process insurance claim are assignable even if the policy prohibits assignment of the policy itself. Typically the insurer cannot cancel a policy. Fire policies are typically not assignable because of the risk. automobile collision. However. If the insured/owner grants a general release to the third party who caused the loss. If he does. Dan cannot waive away Edgar’s liability. no right of subrogation exists with life insurance policies. forfeiture or payment upon the insured’s death. the owner cannot assign the policy without the beneﬁciary’s approval. Assignment typically requires notifying the insurer and adherence to various formalities. Misstatement of age is not material enough to void a policy. If Dan has ﬁre insurance. the current beneﬁciary could lose all rights if the assignee names a new beneﬁciary. then the insurer is released from his obligation to the insured/owner. Again.
3: GUARANTY AND SURETYSHIP Purpose Some individuals contract to share or assume the responsibilities of another person. a creditor can usually assign a principal’s performance to a second creditor. It provides security for the creditor by a third person’s promise to be responsible for the debtor’s obligation. • special guarantor—A special guarantor limits his promise to a single transaction and/or a speciﬁc creditor. For example.Certiﬁed Bank Auditor Examination Review — Volume 7 SECTION 2. if the debtor does not pay or perform. liability is instantly created for the individual who contracted to share the responsibility. In fact. Absolute versus Conditional guaranty agreements • absolute guaranty—An absolute guaranty agreement comes into eﬀect upon the default of the principal. A special guarantor’s promise cannot be assigned to a new creditor. If a general guarantor secures the principal’s promise. Continuing versus Restricted guaranty agreements • restricted guaranty—A restricted guaranty agreement is for a speciﬁed single transaction or speciﬁed group of transactions. then the creditor may similarly assign his rights regarding the guarantor’s performance to a second creditor. Suretyship describes the relationship where one person agrees to be answerable for the debt or default of another person. speciﬁc creditor. As a result. Guaranty and Suretyship Deﬁnitions • party—includes individuals and all types of business organizations • principal. Types of Guaranty Agreements General versus Special guaranty agreements • general guarantor—A general guarantor’s promise is not limited to a single. or obligor—the party who borrows money or assumes direct responsibility to perform a contractual obligation • creditor or obligee—the party entitled to receive payment or performance from the principal or obligor • surety or guarantor—any party that promises the creditor to be liable in case of the principal’s failure to pay or perform Note: Today. a creditor can initiate action against the guarantor at the same time it is initiated against the principal. The general principals herein apply equally to sureties and guarantors. • continuing guaranty—A continuing guaranty agreement covers a contemplated series of ongoing transactions over a period of time. when the other person defaults on the responsibility. In these cases. the distinction between a surety and a guaranty has li�le signiﬁcance. 60 . Banks favor this sharing and assumption of responsibilities as it serves to reduce the risk of default. The two terms are used interchangeably. the creditor has an immediate and direct remedy against the surety. At that point the creditor may go directly to the guarantor to collect. principal debtor.
However. in recognition of the guarantor’s lack of compensation. even though the uncompensated guarantor must perform as promised. bonding companies) receive some pay or other consideration in direct exchange for his contract with the creditor. the law typically protects the uncompensated guarantor against unexpected or enlarged liabilities beyond those speciﬁed in the agreement. Also. both the legal interpretations and enforcement of the contract are eased. Examples of a condition might be (1) requiring the creditor to follow certain collection steps. this raises the concern about the consideration existing and ﬂowing to the guarantor. ambiguous provisions of agreements with an uncompensated guarantor are typically construed in favor of the unpaid guarantor.. since they are viewed as being able to take care of themselves. Compensated guarantors typically frame their own contracts.. However. 61 . the law typically will fully and ﬁrmly enforce any unexpected liabilities or penalties beyond those speciﬁed in the agreement. Some guarantors are compensated and some are not. the consideration given to the principal by the creditor is regarded as suﬃcient contractual consideration in exchange for the guarantor’s promise. Uncompensated Guarantors An uncompensated guarantor (e. With unpaid guarantors. the contract is usually framed by the creditor and only signed by the guarantor. In the case of both compensated and uncompensated guaranty agreements. Compensated guarantors are not as protected by the law as uncompensated guarantors. This is a result of the fact that ambiguous contract language is typically construed against the party writing it. This beneﬁt is the consideration gained by the creditor. or (3) requiring an independent evaluation of the principal’s performance to substantiate that default does indeed exist. For example. Compensated versus Uncompensated Guaranty Agreements A guarantor’s promise to a creditor is contractual in nature and thus its validity and enforcement both depend upon the consideration exchanged between the two parties. in the case of a compensated guarantor. • As with an uncompensated guarantor.g. This could raise concerns about the contract’s validity. • The existence of compensation makes for ﬁrm legal enforcement of the contract against the guarantor. because the guarantor is not compensated. the guarantor’s promise beneﬁts the creditor since the creditor is concerned about the principal’s ability to perform his promise. This completely supports the contract’s legal validity and full legal enforcement. (2) requiring advance notice to the guarantor. In uncompensated guarantor situations. the compensated guarantor must perform as promised upon the principal’s default. Compensated Guarantors Compensated guarantors (e. The consideration received by the guarantor is separate and distinct from the consideration promised to the principal.g. a cosigner on a loan) doesn’t receive pay or anything else in direct exchange for his contract with the creditor.Chapter Two — General Commercial Law • conditional guaranty—A conditional guaranty agreement requires that the other acts (additional to the default of the principal) occur before the guarantor can be held liable. Naturally.
The amount of losses covered is limited to the face value of the bond. whereby the guarantor assumes responsibility for the principal’s performance in the event of default by the principal. A guarantor’s promise to be liable for a principal’s obligation is created separately from and independently of the principal’s promise to perform for the creditor. Fidelity bonds also have a stated maximum amount of losses to be covered. Therefore. if the creditor obtains a judgment against the principal. Guaranty agreements usually result from an express wri�en contract between the guarantor and the creditor.Certiﬁed Bank Auditor Examination Review — Volume 7 • The existence of compensation also makes for very ﬁrm legal interpretations of the contract against the guarantor. A guaranty contract requires consideration. The disclosure duty exists only if the creditor has reason to believe that the guarantor does not know the facts. Other Examples of Guaranties Businesses relationships typically involve some level of trust and therefore risk. a creditor who is aware of the principal's misrepresentation has a duty to 62 . • The most important right of a guarantor who has completed performance is subrogation. A guarantor becomes liable to the creditor only when the principal defaults. However. • A guarantor may not avoid a contract because of misconduct on the part of the principal. In many cases this consideration is the same as that received by the principal. Relationships Between a Creditor and a Guarantor As in other contract relationships. the relationship between the creditor and the guarantor is ﬁduciary in nature and requires good faith and fair dealing. a guarantor promises that the principal will perform as promised—if not. With a performance bond. Basically. A guarantor who has performed the obligation of the principal is subrogated to the creditor’s rights against the principal. even if the principal’s conduct induced him to become a guarantor. Typical standard formats for business bonds are: • Performance bonds—Performance bonds provide coverage against losses resulting from the failure of a contracting party to perform the contract as agreed. Guarantor’s Rights and Responsibilities Guarantors provide beneﬁt to both the creditor and the principal by absorbing risk for them. The bonding company promises to pay the party entitled to performance for losses resulting from nonperformance by the principal. If these factors exist. and if the creditor has a reasonable opportunity to communicate them to the guarantor. the guarantor is secondarily liable a�er the principal. the guarantor will be liable for the debt. A creditor has a duty to disclose to the guarantor all information signiﬁcant to the risk being assumed by the guarantor. a creditor’s failure to inform a guarantor of relevant facts may release the guarantor from liability. Guarantors have responsibilities to both parties and are also entitled to certain rights from both parties. the guarantor receives the beneﬁt of this judgment when he satisﬁes the principal’s debts. • Fidelity bonds—Fidelity bonds provide coverage for losses resulting from the dishonest acts of people. at the time of the contract. Therefore. a bonding company acts as the guarantor. Ambiguities in agreements with a compensated guarantor are construed against the compensated guarantor.
Chapter Two — General Commercial Law inform the guarantor. 63 . For example: • a release of the principal by the creditor. undue inﬂuence. dra�. lack of a primary obligation. may include a clause requiring the creditor to give the guarantor notice of the principal's default within a certain period.g. a large change in the contract. failure to provide required materials.. A guarantor who only guarantees collection is entitled to notice. therefore. failure to make progress payments. or any endorser of a note. The courts will enforce such a clause requiring notice. but he should be kept appraised of what actions are being taken to collect from the principal. 3. dishonor occurred and notice of dishonor was given within the time allowed. A creditor's failure to warn the guarantor may release the guarantor from liability. etc. There are other situations in which the principal has a valid excuse for not performing and thus cannot be considered to be in default of the contract. duress. etc. A guarantor who is a drawer or endorser of commercial paper is entitled to notice. the guarantor can waive it in advance. A collection guarantor is not entitled to immediate notice that the principal had defaulted. A guaranty agreement is of a contractual nature and.) • contract defenses that the principal can assert against the creditor in order to void the contract (e. and lack or failure of consideration. check or certiﬁcate of deposit becomes liable on the instrument if presentment for payment or acceptance occurred within a reasonable time. Guarantor’s and Principal’s Defenses which can defeat a Creditor’s claims There are situations in which the contract itself is void and therefore the principal is not required to perform.. Any drawer of a dra� or check. mutual mistake. • The consent of the guarantor is required before a creditor may return collateral received from the principal. Since this is a loss of subrogation for the guarantor. the guarantor is entitled to notice before the creditor may take legal action against him.) As a general rule. Even in states where there is such a duty. thus ending the contract itself • a modiﬁcation of the creditor-principal relationship (e. fraud.) • nonperformance by the creditor which prevents the principal from performing (e.. illegality. Failure to notify the guarantor of the principal's default discharges the guarantor's liability. the creditor’s acquisition of the principal.g. The principal's lack of capacity does not relieve the guarantor of his liability. • A guarantor becomes liable to the creditor as soon as the principal defaults. 1. impossibility. However. 2. Therefore. These situations can eliminate the guarantor’s liabilities. an individual who becomes a guarantor as an accommodating party is entitled to be notiﬁed of the principal's default. A collection guarantor is discharged to the extent that he suﬀers from a lack of notice.g. the creditor does not have to exhaust his remedies against the principal before seeking to recover from the guarantor. In most states. • In the following three situations. The guarantor can be protected by these defenses whether the principal is relieved of liability or not. etc. a guarantor may also use any defense that the principal can use to reduce his liability to the creditor as well. the following contract defenses are exceptions to this general rule: 1. he is released to the extent of the collateral's value.
Certiﬁed Bank Auditor Examination Review — Volume 7
2. The principal's discharge in bankruptcy does not relieve the guarantor of his liability. 3. If the principal's performance is excused due to the statute of limitations running out, the guarantor is not relieved of his liability. Rule of Releasing As a general rule, when a creditor voluntarily releases the principal’s liability, the guarantor is usually released as well. This is based on the fact that the surety is liable only on the principal’s default. The principal cannot default if the creditor releases his claim against the principal. Therefore, the guarantor cannot be held liable either. Exceptions to the Rule of Releasing The following are exceptions to the general rule of releasing: 1. If a guarantor consents to a principal’s release, the guarantor is not released. 2. If a creditor releases a principal but reserves rights against a guarantor—and the guarantor knows but does not object—the guarantor is not released. 3. A release obtained by a principal’s fraud (e.g., a bad check) does not release the guarantor if the creditor rescinds the release prior to the guarantor ‘s reliance. 4. An extension of time for performance agreement must be a binding, enforceable contract if it is to aﬀect the guarantor ‘s liability. Therefore, it must be for a deﬁnite time and supported by consideration. The creditor’s mere grant of an extension of time for performance has no impact on the guarantor’s liability. This conduct does not injure the guarantor, since he is free to perform at any time and pursue all available remedies upon the principal’s default. 5. If the creditor and principal formalize an agreement to extend the time of performance to a deﬁnite time, a nonconsenting, uncompensated guarantor is released from liability. A nonconsenting, compensated guarantor is relieved only to the extent that he is injured by the extension. If the guarantor consents to the extension, these general rules do not apply. Rule of Discharge • Any other material modiﬁcations in the creditor-principal agreement typically discharge the guarantor. A modiﬁcation agreed upon by the creditor and principal acts as a novation (see Section 9.6, Contracts for a deﬁnition) and releases the guarantor from liability. Exceptions to the Rule of Discharge 1. A guarantor who consents to the modiﬁcation is not discharged. 2. A nonconsenting, uncompensated guarantor is not discharged to the extent the modiﬁcation beneﬁts the guarantor. 3. A compensated guarantor is not discharged if the modiﬁcation does not materially increase the guarantor 's risk. Rule of Reimbursement A principal owes a guarantor the duty to perform and not to default. A�er the guarantor has satisﬁed the creditor’s claim, the guarantor has the right to be reimbursed by the principal.
Chapter Two — General Commercial Law
Exceptions to the Rule of Reimbursement 1. If the principal informs the guarantor of a valid defense that can be asserted to deny the creditor’s claim, and if the guarantor fails to use the defense, the guarantor is not entitled to reimbursement by the principal. 2. If a guarantor performed for the creditor a�er a principal had already performed or had been released, the guarantor is not entitled to reimbursement by the principal. However, in this case the guarantor does have the right to have the value of his performance returned from the creditor. Coguarantors or Subguarantors Any contract may have two or more guarantors called coguarantors or subguarantors. Coguarantors are jointly and severally liable to the creditor. This means that the creditor may sue them jointly or separately. A subguarantor promises to be liable if the guarantor defaults, in other words he is a guarantor’s guarantor. Typically, a subguarantorship is created by agreement of the parties, and a coguarantorship is created by implication.
SECTION 2.4: PARTNERSHIPS
Purpose Bank transactions are based upon an accurate understanding of the ﬁnancial status of each party, speciﬁcally the party’s assets and liabilities. It is essential to develop clear comprehension of all obligations (liabilities) that can ensue from a partnership. Partnership Deﬁnitions • partnership—A partnership is an association of two or more people to carry on as co-owners of a business for proﬁt. Competent parties agree to place their money, property or labor in a business and to divide the proﬁts and losses. Each person could be personally liable for the debts of the partnership. Express partnership agreements may be oral or wri�en. • general partner—A general partner is liable for all partnership liabilities plus any unpaid contributions. • limited partner—A limited partner is obligated to the partnership to make any contribution stated in the certiﬁcate, even if he is unable to perform because of death, disability or any other reason. • silent partner—A silent partner does not participate in management • secret partner—A secret partner may advise management and participate in decisions, but his interest is not known to third parties. • dormant partner—A dormant partner is both silent and secret. Essential Elements of a Partnership The basic essential elements of a partnership are: a common interest in the business and management, and a share in the proﬁts and losses. Most partnerships start with a pool of the partners’ capital. The partnership then conducts business using that capital, paying out costs and salaries. the remaining funds are proﬁts and are returned to the partners in proportion
Certiﬁed Bank Auditor Examination Review — Volume 7
to the amount of capital each has put into the pool. Typically, proﬁts do not stay within the partnership but are ﬂowed out to the partners. Different Forms of Partnerships
General Partnerships All partners are general partners. All partners manage the partnership together. If partnership obligations exceed partnership assets: all partners are personally obligated to pay partnership debts or tort liabilities (fraud, malpractice, etc.) Limited Partnerships one or more general partners with one or more limited partners General partners manage; limited partners have less say. If partnership obligations exceed partnership assets: only general partners are personally obligated to pay partnership debts or tort liabilities (fraud, malpractice, etc.) Limited partners are only obligated to the extent of their existing contributions to the partnership. Note: Each partner is obligated to pay his own tort liabilities, whether a general or limited partner When a general partner dies or retires, partnership must be dissolved. (It can be restarted again without him.) Death or withdrawal of a limited partner is less disruptive: partnership can buyback his interests. Limited Liability Partnerships (LLP) one or more general partners with one or more limited partners General partners manage; limited partners have less say. If partnership obligations exceed partnership assets: no partner is personally obligated to pay partnership debts or tort liabilities (fraud, malpractice, etc.) Every partners’ personal wealth is protected and creditors can be left uncompensated. Note: Each partner is obligated to pay his own tort liabilities, whether a general or limited partner. When a general partner dies or retires, partnership must be dissolved. (It can be restarted again without him.) Death or withdrawal of a limited partner is less disruptive: partnership can buyback his interests. When a partner dies or withdraws, the partnership does not need to be dissolved. Limited Liability Companies (LLC) All partners are considered members. Either members manage or they select a manager. If partnership obligations exceed partnership assets: no partner is personally obligated to pay partnership debts. Every partners’ personal wealth is protected and creditors can be left uncompensated.
When a general partner dies or retires, partnership must be dissolved. (It can be restarted again without him.)
The Partnership Agreement The partnership agreement is called the articles of partnership and contains items such as the names of the partners and the partnership, its purpose and duration, the capital contributions of each partner, the method of sharing proﬁts and losses, the eﬀect of advances, any salaries to be paid the partners, the method of accounting and the ﬁscal year, the rights and liabilities of the partners on the death or withdrawal of a partner, and the procedures to be followed on dissolution. The Uniform Partnership Act or other partnership statutes are also a part of the agreement. Provisions of a Partnership Agreement • proﬁt-and-loss provision—Unless the agreement states otherwise, each partner has a right to share equally in the proﬁts of the business and a duty to contribute equally to the losses.
Duties And Powers Of Partners The duties. assigned or disposed of in any manner agreed on by the partners. These statutes require public notice as to the actual identity of the partners. • death provisions—These provisions regarding the disposition of partnership property upon death of a general partner. Buy-sell agreements provide a method whereby the surviving partner(s) can buyback (i. rights and powers of partners are both expressed (in the agreement) and implied (created by law). • ﬁrm name—The parties involved in a partnership select a name subject to two statute limitations in most states: a. Rights. Most states allow partnership to sue or be sued in the ﬁrm name. • partnership capital provision—The capital of a partnership consists of the total credits to the capital accounts of the various partners.Chapter Two — General Commercial Law Capital contributed by the partners represents a liability of the business to the contributing partners. • provisions relating to goodwill—In evaluating the assets of a ﬁrm. Partnerships may also declare bankruptcy as a ﬁrm. The agreement states the method to be used in determining the purchase price. If the partnership agreement speciﬁes the division of proﬁts but fails to mention losses. goodwill is typically considered. or the remaining partner or partners can purchase the interest of the withdrawing partner. These credits must be for permanent investments in the business. If the name is other than that of the partners. • provisions relating to partnership property—O�en the property classiﬁed as partnership property is determined by agreement between the parties. The provisions of such an agreement should be agreed upon before either party knows whether he is a buyer or a seller. • salary provisions—These provisions are to determine the salaries for partners who work within the business operations of the partnership. 67 . purchase) the interest of the deceased partner. the losses are divided in the same proportion as the proﬁts. A partnership may not use the word “company” or other language that would imply the existence of a corporation. If there is no express agreement. The statutory law in most states is the Uniform Partnership Act. Goodwill can be sold or transferred. Note: The ﬁrm name is considered an asset and may be sold. the classiﬁcation of partnership property is determined by the conduct of the parties and the way the property is used in the business. as well as the time and method of payment and whether a partner has the option or the duty to purchase the interest of a dying or withdrawing partner. Buy-sell agreements are used to cover this contingency.e. Most property acquired with partnership funds is partnership property. • special authorization for one partner to admit new limited partners—If there is no special provision then the default position is that the partners will unanimously decide. The partnership agreement determines the amount that each partner is to contribute plus the credit to be received for contributed assets. b. Generally. there must be compliance with the assumed name statutes. The partnership is obligated to return this capital to the partners at the time of dissolution. buy-sell agreements are funded by the partnership’s purchase of life insurance on each partner’s life. • buy and sell provisions—All partnerships should provide for the contingency of death or withdrawal of a partner.
a partner’s earnings on his capital investment are his share of the proﬁts. and if the partnership agreement makes no provision for arbitration. limited) have an equal legal right in management and conduct of business. Partnership Duties It must be remembered that a breach of these duties creates a liability to the partnership. Each partner has the right to review and copy partnership ﬁnancial and business records (on-site). The partners may agree to place management within the control of one or more partners (managing partners) or may hire nonpartners to manage. • Each partner must not impede the partnership’s ordinary business. even if their capital contributions are not equal. Proﬁts that are not withdrawn but are le� in the partnership are not entitled to draw interest.Certiﬁed Bank Auditor Examination Review — Volume 7 Partnership Rights Control of the Partnership Usually. Ordinary ma�ers are decided by a majority of the managing partners. general partners have more management inﬂuence over the business than the limited partners. The payment of a salary to a partner requires either an express agreement stating such or may be implied from the partner’s conduct. 68 . If the partnership consists of two persons who are unable to agree. Matters requiring Unanimous Consent • changing the essential nature of the business by altering the original agreement or reducing or increasing a partner's capital • embarking on a new business • admi�ing new general or limited partners (note: some partnership agreements allow for admission of additional limited partners by nonunanimous decision) • modifying a general or limited partnership agreement • assigning partnership property to a trustee for the beneﬁt of creditors • confessing a judgment • disposing of the partnership's goodwill (or the partnership’s name or other signiﬁcant assets) • submi�ing a partnership agreement to arbitration • performing an act that would make impossible the conduct of the partnership business Note: Engaging a new client does not require the unanimous consent of the partners. All partners of the same type (general. Interest may be paid on advances to the partnership above the amount of originally contributed capital. A partner has the right to assign his proﬁt income from the partnership to another party. but he cannot sell or assign his rights to the partnership property. then dissolution is the only remedy. • Each partner has the duty to give the person responsible for record keeping any information necessary to eﬃciently and eﬀectively carry on business. Capital contributions are not entitled to draw interest. but they may receive a salary. Financial Returns from the Partnership Partners are not entitled to payment for services rendered in conducting the partnership’s business.
to make admissions against interest g. a partner cannot bind the partnership without the authorization of the other partners. to receive notices • power to impose tort liability—The law imposes tort liability (for an explanation of tort liability see section 9. Possession of partnership property for nonpartnership purposes requires the other partner's permission. adjust. A partner who possesses knowledge and does not reveal it to the other partners has commi�ed an act of fraud against the partnership and against the partners.5 Agency) on a partnership for all wrongful acts or omissions of any partner acting in the ordinary course of the partnership and for its beneﬁt. • Surviving partners. to buy property within the scope of the business for cash or on credit d. to compromise. since a partner is considered an agent for the partnership business. Any inside or outside knowledge possessed by one partner and not revealed to the other partners is still considered notice to the partnership and the partnership is liable as if all partners had known the information. A partner may bind the partnership with contractual liability whenever he is apparently carrying on the partnership business in the usual manner. to hire employees f. Otherwise. Partnership Powers • power to contract—The general laws of agency apply to partnerships. to sell goods in the regular course of business and make warranties c. • Each partner has the duty to communicate known facts to the other partners and have the facts added to the partnership records. Therefore. in the case of a partner's death. Implied powers to contract a. Using partnership information for personal gain (without permission) is a breach of this duty. must wind up the aﬀairs of the partnership in accordance with the partnership agreement and the applicable laws. • Each partner has a duty to refrain from using partnership property for personal use or beneﬁt. A partner cannot transfer partnership property or use partnership property in satisfaction of his personal debts. and se�le claims or debts owed by or to the partnership b.Chapter Two — General Commercial Law • Each partner must act in accordance with the partnership agreement. Note: Property includes physical assets as well as manpower and informational resources. since a partnership is a ﬁduciary relationship. to enter into contracts within the scope of the ﬁrm h. 69 . • Each partner owes the others undivided loyalty. The partnership has the right of indemnity against the partner at fault. to buy insurance e. even though each has an equal right to possess partnership property for partnership purposes. Each partner must exercise good faith and consider the mutual welfare of all the partners in conducting business.
he should be chargeable as a partner unless he takes reasonable steps to give notice that he is not. an important caveat exists when an individual who is not a partner conducts himself as though he has authority and makes commitments with an outside party. However. then the enterprise is permanently extinguished and the people leave with their shares of the partnership ﬁnances. It can be the beginning of the end (“b” above) or a step in restructuring the partnership (“a” above). Each partner has an implied power to borrow money and to extend the credit of the ﬁrm. then that person is an apparent partner and is liable to any party to whom such representation has been made.. when dealing with an outside party only a partner can make commitments that are binding on the partnership.e. Usually. by signing negotiable paper. or by conduct) represents himself as a partner in an existing partnership. Steps in Extinguishment 1. adding or subtracting a partner and adding or subtracting that partner’s ﬁnances. Some of the people could then get back together. • ﬁnancial transactions—Partnerships are divided into trading and nontrading partnerships to determine the limit of a partner’s ﬁnancial powers. A partner does not have the implied power to borrow money. The right to sell a business’ real property is implied only if it is in the real estate business. although typically they do not. b.) then the enterprise is still going to continue doing business. Extinguishment of a Partnership Extinguishment can occur two ways: a. With regards to an outside party. partnership liability may be predicated on the legal theory of estoppel. A trading partnership engages in the business of buying and reselling merchandise. in the usual course of business. albeit with changes in the ﬁnances and people involved. through restructuring—If the partners are restructuring (i. Acts of Nonpartners Acts of nonpartners who have apparent authority may bind the partnership. Other transfers of real property require partnership authorization.Certiﬁed Bank Auditor Examination Review — Volume 7 • powers over property—Partners have implied authority to sell to good-faith purchasers personal property that is held for resale and to execute the necessary documents to transfer title. If a person (by words spoken or wri�en. To sell the ﬁxtures and equipment used in the business requires the other partners’ authorization. In these partnerships. Some courts claim that if a person is held out as a partner and he knows it. permanently—If the partners cease doing business together and the entire enterprise is stopped. Other courts claim that there is no duty to deny false representation of partnership if the apparent partner did not participate in making the misrepresentation. a partner’s powers are more limited. A nontrading partnership engages in the production of merchandise from raw materials or sells services. The apparent partner may even be liable if credit is extended to the partnership. dissolution—Dissolution is the legal destruction of the existing partnership relation. This destruction occurs whenever any partner ceases to be a member of the 70 .
application of an innocent party. through an act of the partners—A partnership at will occurs when a deﬁnite term of duration of a partnership is not speciﬁed in the agreement. As far as third parties are concerned apparent authority exists until notice of termination is given. paying oﬀ the creditors and distributing the balance to the partners. through a court decree—A court of equity may order dissolution under the following circumstances: a. Usually. a declaration by judicial process that a partner is insane c. it doesn’t necessarily mean that the remaining partners will cease doing business together. Dissolution is the ﬁrst of three steps in scenario “b” above. (in some states) any grounds that are equitable or in the best interests of the partners 3. (See scenario “b” above. dissolution itself does not actually terminate the partnership. dissolution most o�en means that one or more partners are exiting the partnership. 71 .Chapter Two — General Commercial Law ﬁrm or a new partner is admi�ed. 2. (See scenario “b” above. because the partnership was entered into as a result of fraud e. through an operation of law—Dissolution by operation of law occurs when events make it impossible or illegal for the partnership to continue. Dissolution also terminates the actual authority of a partner to bind the partnership. except as necessary to wind up the business. a partner is unable to conduct business and to perform the duties required under the contract of partnership b. a change in the law or a revision that makes the continuance of the business illegal. 2.) 3. All the partner would have to do is give notice to the other parties. Dissolution is the only step in scenario “a” above. This is done a�er dissolution only when the partnership plans to cease all partnership operations. a breach of the partnership agreement. dissolution ends the actual authority of any partner to act for the partnership except to wind up partnership aﬀairs. There are three ways to dissolution most commonly occurs: 1. liquidate the assets of the ﬁrm in an orderly manner or complete transactions begun but not ﬁnished. it speciﬁes the time when partners cease to do business as they have in the past and (in the case of one partner exiting and the others remaining) start a new partnership structure. impossibility of carrying out the purposes of the partnership agreement due to the gross misconduct and neglect or breach of duty by a partner f. any partner may legally dissolve the partnership at any time and take his share of the partnership. With this type of partnership. termination—Termination occurs when the winding-up process is completed. However. These events include the death or bankruptcy of a partner. misappropriation of funds or commitment of fraudulent acts by one of the partners d. The other partners o�en choose to continue doing business.) Step #1—Dissolution Remember. winding up—Winding up is the process of reducing the assets to cash.
A�er dissolution of a partnership the partners have no authority to create liability but existing liabilities are not discharged. These suits are equitable in nature and must be ﬁled in a court of equity. Remaining assets are used to return capital contributions and distribute any proﬁts. 2. The remaining partners must se�le with the withdrawing partner for his interest in the partnership and for compensation. each partner has the right to insist that all of the partnership assets be used ﬁrst to pay ﬁrm debts.e. (i. This agreement may be expressed or implied from the parties’ conduct.. If the dissolution is caused by an act of the parties. third parties may lay claim to the partners’ individual property for all debts created while the partnership existed. Parties Entitled to Notice of Dissolution: 1. the value of the withdrawing partner's interest in the partnership is ascertained as of the date of dissolution. If a ﬁrm’s assets are insuﬃcient to pay its debts.) The partnership is then liquidated. The ﬁrm's creditors. Notice by publication in a local newspaper is suﬃcient public notice. A majority of the partners selects the method and procedures to be used in winding up. If the duration of a partnership is ﬁxed by agreement and one partner wrongfully withdraws.e. • A withdrawing partner may not require the partnership to cease doing business. In lieu of interest.) In this case. and the assets distributed among the partners.Certiﬁed Bank Auditor Examination Review — Volume 7 Rights of Partners in a Dissolution If the dissolution is caused in any other way than breach of the partnership agreement. or the continuation of the business becomes illegal. The partners may deduct from the amount due any damages caused by the wrongful dishonor. However. A ﬁrm’s creditors are not bound by an agreement between the partners that one or more of the partners will assume the partnership liabilities and that the withdrawing partner will not have any liability. the withdrawing partner may receive the proﬁts a�ributed to the use of his rights in the property of the dissolved partnership. The only way a withdrawing partner may be discharged from existing liability is by agreement with the creditors. including former creditors. require that the partnership be wound up and terminated. 72 . creditors of the individual partners have ﬁrst claim on their individual property. The withdrawing partner may then receive the value of his interest in the partnership plus any future interest. Notice eliminates the apparent authority to bind the former ﬁrm and its partners. Notice of dissolution is required unless a partner becomes bankrupt. Step #2—Winding Up A partner’s share of the partnership assets or proﬁts may be determined in a suit for an accounting.. allow the business to continue or accept the fact that it has continued. are entitled to actual notice of the dissolution. the remaining partners may continue the business under the same name for the remainder of the term. Rights of the Withdrawing Partner • A withdrawing partner who has not breached the partnership agreement may on dissolution require the partnership to cease doing business. withdrawing partners and the estate of deceased partners can be bound by transactions entered into a�er dissolution. public notice must be given. (i. If such notice is not given.
The descending order of asset distribution of a limited partnership is as follows: 1.Chapter Two — General Commercial Law Partners may make a complete accounting and se�le their claims without resort to a court of equity. • Each partner is entitled to return of his capital contributions. If a ﬁrm is insolvent and a court of equity is responsible for the distribution of the partnership assets. to general partners in respect of their capital contributions 73 . • Any remaining balance is distributed as proﬁts in accordance with the partnership agreement. to limited partners in respect of their proﬁts 4. to general partners in respect of their proﬁts 7. The ﬁrm’s creditors must exhaust the ﬁrm’s assets before recourse to the partners’ individual assets. to unsecured creditors other than partners 3. All ﬁrm creditors other than partners are entitled to be paid before the partners are entitled to participate in any of the assets. A partner is entitled to a formal accounting in the following situations: • the partnership is dissolved • an agreement calls for an accounting at a deﬁnite date • one partner has withheld proﬁts arising from secret transactions • an execution has been levied against the interest of one of the partners • one partner does not have access to the books • the partnership is approaching insolvency and all parties are not available Step #3—Termination Distribution of Partnership Assets The assets are distributed among the partners as follows: • Any partner who has made advances to the ﬁrm or has incurred liability for—or on behalf of—the ﬁrm is entitled to reimbursement. to general partners in respect of any loans to the partnership 6. they are distributed in accordance with a rule known as marshalling of assets. An accounting is performed on the dissolution of a solvent partnership and winding up of its business. The ﬁrm’s creditors may seek payment out of the ﬁrm’s assets and then the individual partner assets. to secured creditors other than partners 2. to limited partners in respect of their capital contributions 5.
Admitting a New Partner If a partnership admits a new partner. an individual may have additional liabilities arising from either acting as an agent for another person or from having an agent acting on his behalf. he frequently does business with another person. This other person is third party. However. or (3) the action involves a personal covenant or transaction entirely independent of the partnership aﬀairs. even if he is a general partner. In cases where the agent commits some wrong or has an accident. the principal instead contracts the agent to carry out the act or role for him. P hires A to be his delivery van driver. Main Deﬁnitions • agency—the ﬁduciary relationship that exists when one party acts on behalf of and under the control of another 74 . (2) the action involves a segregated or single unadjusted item or account. Types of Parties. the new partner is not personally liable for such obligations.Certiﬁed Bank Auditor Examination Review — Volume 7 The asset distribution hierarchy of a limited partnership is shown below: First priority Creditors Limited partners Last priority General Partners Secured Unsecured Capital contributions Loans Proﬁts Capital contributions Actions Against Other Partners Typically a partner cannot maintain an action at law against the other partners. because the indebtedness among the partners is undetermined until there is an accounting and all partnership aﬀairs are se�led. For example: P contracts A to sell his car. the new partner is liable to the extent of his capital contribution for all obligations incurred before his admission. the agent (A) and the third party (T). Having an agent or acting as an agent can create substantial tort or contract liabilities. Rather than perform some act or role himself. the person harmed is also called the third party. SECTION 2. there are exceptions to this rule if: (1) the partnership is formed to carry out a single venture or transaction. Principals and Agents Three types of parties are involved in agency arrangements: the principal (P).5: AGENCY Purpose Besides any routine personal liabilities. T is the person who buys the car from A. However. When the agent is carrying out the act or role. T is the person that A runs over.
partially disclosed principal—The third party knows that a principal exists but does not know the principal’s identity. (For a more detailed review of the statute of frauds. A principal must be legally competent (not insane. A power of a�orney may also be narrowly wri�en and thus closely limit the permissible scope of the agent’s actions to a single aspect or transaction. Other states allow a minor to be a principal and to appoint an agent.6-Contracts. see section 9. an independent contractor’s mistakes or misdeeds o�en do not implicate the principal. general agent—an agent who is authorized to conduct a series of transactions in the continuous service of the principal 4. factor—an agent who has possession and control of another’s personal property and is authorized to sell that property 3.) 75 . Frequently. those agent’s actions are voided. it is not unreasonable or unlimited. Who can be an Agent? Anyone can be an agent provided that they actually consent to that role. However. and therefore. • agent—the party who acts for the principal 1. independent contractor—a person whose services are contracted for by another person. The agency may be either expressed or implied. limited authority to obtain a customer for an owner who wants to sell or exchange property 2. broker—an agent with special. A general power of a�orney gives the agent the authority to act in most respects for the principal and has a broad scope of authority. Who can be a Principal? Typically anyone who may act for himself may also act through an agent. a power of a�orney is signed by the principal in the presence of a notary public. If an agent is to negotiate a contract required to be evidenced by a writing under the statute of frauds. undisclosed principal—The principal’s existence is a secret from the third party. 3. However. any agreements made by the agent on the minor principal’s behalf are voidable (by the minor) as though the minor had made them himself. Some states hold that a minor cannot validly appoint an agent. most states require that the appointment of the agent must also be evidenced by a writing. Because he works under his own direction and not the principal’s. This is a formal document for conferring authority on an agent. disclosed principal—An agent for a disclosed principal reveals the principal’s identity. An agent needs only to be appointed—either in writing or orally—by the principal. The agent in this case is called an a�orney in fact. 2. The independent contractor has a certain end result to accomplish and may determine the manner and methods used to obtain that result. special agent—an agent who is not in the continuous service of the principal 5. power of a�orney—One common type of agency is the power of a�orney. nor deceased).Chapter Two — General Commercial Law 1. • principal—the party who controls the agent and for whom the agent acts 1.
unless it is illegal or immoral. if the liability results from obeying the principal’s instructions. Any proﬁt realized by the agent in such a transaction belongs to the principal. An agent who exceeds his actual authority and binds the principal to the third party is liable to the principal for any resulting loss or damages. • duty to inform—Knowledge obtained by the agent. The principal may rescind any transaction that violates the duty of loyalty. Implied Duties of an Agent An agent has a duty to always remain within the scope of his principal’s conferred authority. An agent may be liable to the principal for any loss that may occur due to his not following instructions. while acting within the scope of his authority. • duty to compensate in general—An agent is entitled to compensation for his services. • duty to compensate sales representatives—A salesperson is entitled to a commission on sales solicited and induced by him. an agent may not enter into an agreement on the principal’s behalf if the agent is the other contracting party. the amount of compensation is the reasonable value of the agent’s services—taking into account past custom and practice. This is determined by the conduct of the parties and the nature of the information.Certiﬁed Bank Auditor Examination Review — Volume 7 Implied Duties of a Principal • ﬁduciary duty—The principal must be loyal and honest in dealing with the agent. • duty of loyalty—Any ﬁduciary relationship is based upon the duty of loyalty. While employed by the principal. an agent should not undertake a business venture that competes or interferes with the principal’s business nor make any contract for himself that should have been made for the principal. An agent who fails to inform the principal can be liable to the principal for any resulting damages. Therefore. An agent has no reason to question a procedure outlined by the principal. • duty not to be negligent—An agent has a duty to act in good faith and to exercise reasonable care and diligence in performing his tasks. conﬁdential. The important issue in cases involving trade secrets is whether the information sought to be protected is. The amount of compensation is commonly stated in the contract. Failure to perform may result in discharge. Note: An agent may not represent two principals in the same transaction if the principals have diﬀering interests. the agent is required to disclose all material facts to the principal. If not. • duty to reimburse—A principal has the duty to reimburse the agent for any reasonable expenses incurred on behalf of the principal. Breach of this duty can result in the principal’s enjoining the agent’s new business or recovering money damages or both. Therefore. • duty to protect conﬁdential information—An agent has a duty to protect the principal’s conﬁdential information—usually called a trade secret. In fact. in fact and law. is considered notice to the principal and is binding on the principal. • duty to indemnify—A principal must hold an agent harmless or free from liability for certain tort losses. Note: Knowledge obtained by the agent while acting outside his scope of authority is not eﬀective notice to the principal. if the principal becomes 76 . any breach of a duty creates an agent’s liability. The principal may also collect an amount equal to any damages sustained as a result of the breach. • duty to obey instructions—An agent has a duty to obey all instructions issued by the principal as long as they fall within the duties outlined in the contract. In addition.
Delegation of Authority and Liabilities Agent’s Authority Most business contracts are entered into by agents on behalf of their principals. Mr. In that case. • duty to account—An agent must maintain proper records showing receipts and disbursements. For an agent to create a binding contract between the principal and third party. These subagents are considered true employees of the principal and are entitled to compensation from the principal. the agent is liable to the principal to perform the contract as instructed. inconsistent with the intent to reject the contract. The principal’s conduct. the principal may recover from the agent. These contracts bind the third party and principal contractually. Ratiﬁcation requires that the principal— with knowledge of all material ma�ers—express or imply adoption or conﬁrmation of a contract entered into on his behalf by a person with no authority to do so. However. A principal may bind himself by ratifying an unauthorized contract. For example. On the other hand. when an agent enters into a contract for the purchase of real property from Mr. an agent of an undisclosed principal may be liable to the third party: • if the principal se�les with the agent before becoming disclosed • if the third party elects to hold the agent liable instead of the principal a�er the principal's disclosure • based on the way the agent signs the agreement or due to the language of the agreement • if the agent exceeds his actual and apparent authority and the principal does not ratify 77 . because the principal takes the agent’s place for liability purposes. the agent must have the actual. the agent may have actual authority to appoint other agents for the principal. Agent’s Delegation of Authority An agent may delegate his duties to a third party called a subagent only if the agent’s acts require no discretion and are purely mechanical. Agent’s Liabilities An agent acting within the scope of his authority is not liable to the principal. An agent may be granted actual authority to act on behalf of a principal. The acts of the subagent are considered acts of the agent.Chapter Two — General Commercial Law liable because of negligent acts on the part of the agent. apparent or inherent authority or the principal must have ratiﬁed his actions. Agent’s Authority. the principal may allow the agent to believe himself to possess authority. The one exception to this rule is when an undisclosed principal has se�led with the agent prior to the principal’s disclosure to the third party. implies ratiﬁcation. Jones without disclosing that he is acting for a principal. Jones can make claims against either the agent or the principal. Undisclosed Principal/Agent Liabilities It is not common for an agent to become bound to a third party. In certain cases.
If an agent or servant commits a tortious act. A third party must perform for an undisclosed principal if the contract is assignable and created by an authorized agent. Tort Liabilities In the language of tort liability. a tort has been commi�ed and the person who commits a tort is personally liable to the person whose property or body is injured or damaged. master or employer. since it is assumed that the master is in a be�er position to pay for the wrong than the servant. If two people were responsible for the action. the opposite is not true. the materials used. In recognition of the principal’s lack of involvement. This concept imposes vicarious liability on employers as a ma�er of public policy. servant or independent contractor is not liable for the torts. They include: • nature of the employment—What does the agent do for the employer? What was he doing when the tort occurred? • right of contract (not only as to the ultimate result but also as to the means used to get there)—How much latitude does the agent have in doing his work? • instrumentality—The instrumentality used in the tort could be the building where the tort occurred. This is called joint and several liability. However.Certiﬁed Bank Auditor Examination Review — Volume 7 Other’s Liabilities A third party is liable to a disclosed principal for any contract created by an authorized agent. or the vehicle or equipment used in commi�ing the tort. master or employer can be held jointly and severally liable for the torts (along with the agent). If the third party does not perform. A servant is a person who is employed with or without pay to perform personal services for a master and is subject to the master’s right or power of control. If a person’s action causes injury to someone. they can share liability for the injury. an independent contractor working autonomously is liable for his own mistakes or misdeeds and usually does not share liability with the principal. Determining if a tort is committed within the scope of employment There are several factors to take into consideration when determining whether a tort is commi�ed within the scope of employment. Respondent superior is a concept which states that a master is liable to third persons for torts commi�ed by his servants within the scope of their employment and in pursuance of the master’s business. Note: The agent is not relieved of liability for his tortious act even if the tortious act is commi�ed under the direction of a principal. a master is one who employs another person. An agent. As described above. an agent for an undisclosed principal can enforce the contract and may sue in his own name. • furnishing the instrumentality—Was the instrumentality furnished by the employer or the agent? • authorization—Was the agent’s use of the instrumentality authorized? • time—Did the tort occur during work hours or during a work task? 78 . then the principal. The master is liable only when his business is being carried on or the wrongful act was authorized or ratiﬁed. mistakes or misdeeds of the principal. an independent contractor renders services but retains control over the manner of rendering such services.
Liability of Disclosed versus Undisclosed Principals A disclosed principal protects his agent from liability as long as the agent is acting within his granted scope of authority. Either party has full power to terminate the agreement even though he has no right. 79 . The parties may also mutually agree to cancel their relationship. Undisclosed principals become liable to third parties only when the agent acted within the scope of actual authority and the contract is of the type that can be assigned to the undisclosed principal. The breaching party may become liable for damages suﬀered by the other party.Chapter Two — General Commercial Law Exceptions Most courts inquire as to the intent of the servant and the extent of deviation from expected conduct involved in the tort. connectability—The master is not liable if the employee’s act has no reasonable connection with his employment. Thus. frolics—A frolic occurs when a servant neglects his master’s business and pursues his personal interests. Therefore. If the termination occurs prior to the termination date stated in the agreement. destruction or illegality—The master is not liable if the employee’s act involves destruction or illegality of the agency’s subject ma�er. Termination of the principal-agent relationship may also occur by: a. This means that in certain exceptional situations the master is not liable for torts commi�ed by the servant. Termination of Principal-Agent Relationships The agency relationship is terminated upon the death. Disclosed principals also become liable to third parties if they ratify an unauthorized contract. a disclosed principal becomes liable to a third party who enters into a contract with an authorized agent. Undisclosed principals are liable to agents who enter into contracts within their actual authority. However. and there is no principal-third party relationship with an undisclosed principal. Neither apparent authority nor ratiﬁcation can occur since these events arise from the principal-third party relationship. mutual agreement—The parties may agree in their contract to terminate the relationship at a deﬁnite point in time or on completion of a task. if the principal does not ratify the contract. b. 3. 2. any discussion of an undisclosed principal’s liability applies to a partially disclosed principal as well. Such exceptions include: 1. bankruptcy or incapacity of either party. 4. unilateral action—Either party to an agency agreement may act independently in terminating an agency unilaterally. it is considered a wrongful termination. Any time prior to ratiﬁcation. intentional torts—The master is not liable if the intentional tort has nothing to do with his business and is prompted by a feeling of ill will toward the third party. the third party may withdraw from the contract. The law views the liability of partially disclosed and undisclosed principals as being the same. an agent who exceeds his authority becomes personally liable to the third party.
but does terminate on death. For example. then the principal must give personal notice to the third party. A valid contract creates legally enforceable obligations. Notice may be given personally or publicly (constructive notice). Both parties have the legal right to terminate the relationship.e. yet still be legally enforceable. a mortgage or security agreement. If a third party has dealt with an agent and if the agent is terminated by the acts of the principal or agent. if the third party has not dealt with the agent public notice is suﬃcient. ﬁxed or contingent. an agent may have a right to sell a certain asset belonging to the principal and apply the proceeds on a claim against the principal. • agency coupled with an obligation—An agency coupled with obligation is created as a source of reimbursement to the agent. his accrued ﬁxed and contingent obligations could be a very substantial portion of his overall ﬁnancial status. SECTION 2. Some obligations may be contingent and depend on future circumstances. Exceptions Exceptions to the termination of an agency agreement include: • agency coupled with an interest—This relationship exists when the agent has an actual beneﬁcial interest in the property that is the subject ma�er of the agency (i.6: CONTRACTS Purpose Two or more parties intending to transact business can form a contract and therefore bind themselves and each other to their speciﬁc promises. either the principal or the agent may terminate the relationship. In all cases. the agent’s apparent authority will continue to exist. The type of notice required depends on the third party’s relationship to the agent. The law sanctions the commitment by pu�ing its legal enforcement machinery behind it. 80 . there is no breach of contract and no liability is incurred.) This type of agency cannot be terminated unilaterally by the principal and is not terminated by events such as death or bankruptcy of the principal. This type of agency cannot be unilaterally terminated by the principal. incapacity or bankruptcy. These ma�ers usually receive public notice. Deﬁnitions • contract—A contract is a commitment concerning the future conduct of the parties. and third parties become aware of the termination. In this case.Certiﬁed Bank Auditor Examination Review — Volume 7 c. If an individual has formed contracts with other parties. Notice of Termination A principal must give notice of an agency termination to all third parties who have learned of the agency. If the agency is terminated by action of law. bankruptcy or incapacity of the principal. the principal is not required to notify third parties. If proper notice is not given. all of his contractual commitments must be carefully reviewed and understood as current or future. Legally enforceable obligations can be completely ﬁxed and ﬁnal.. termination at will—When the agency agreement does not state a deﬁnite time period. such as death. When assessing an individual’s ﬁnancial status.
For example.. (i.) • oﬀeree/promisee—An oﬀeree or promisee is one of the parties to a contract.) • option contract—An option contract is an oﬀer that cannot be revoked for a certain time period so that the oﬀeree can decide whether or not to accept it. but A refuses to honor the unspoken agreement. the one who makes the oﬀer. • valid—A valid contract adheres to the legal requirement for a contract and is enforceable in court by either party. B then gives some beneﬁt to A. • avoid—Avoid is a verb meaning to undo or make void an agreement or action. the oﬀeror promises the oﬀeree a beneﬁt if the oﬀeree performs some act. The doctrine of mutuality of obligation applies only to bilateral contracts.. • implied-in-fact contract—When the agreement is manifested only by the two parties’ conduct.) • unilateral contract—A unilateral contract is a promise exchanged for an act of performance. The law will enforce the contract unless one party elects to disaﬃrm it. • void contract—A void contract is not a contract in the eyes of the law. • performance—Performance is the term used to describe what the promisee/oﬀeree and promisor/oﬀeror agree to do for one another. bargained-for consideration—This legally validates that there was some sort of exchange at the basis of the mutual assent. it is an express contract. the one who receives the oﬀer and accepts or rejects it. 81 . typically the one who responds to the ﬁnal exchange of promises. Note: Courts permit the party who has conferred a beneﬁt to recover the reasonable value of that beneﬁt. when A’s conduct (mis)leads B to think they have a certain ﬁrm agreement and B relies upon that agreement.e. Elements of a Contract All these elements are required for a contract to be valid and enforceable: 1. • voidable—A contract is voidable if one or more parties have the power to end it.e. (i. • executory performance—An executory performance contract has yet to be performed by the contracting parties.) • bilateral contract—A bilateral contract is a promise exchanged for another promise.e. There is no legal machinery to protect the bargain of the parties and it will not be enforced in court. mutual promises (Most contracts are of this type. 2. • implied-in-law or quasi contract—This is similar to an implied-in-fact contract. it is an implied-in-fact contract. but not in any writing. This is to prevent the unjust enrichment of one party at the expense of another. typically the one who initiates the ﬁnal exchange of promises. • mutuality of obligation—This requires that each party be bounded or neither party is bound.. A wri�en agreement is only required in certain situations. in other words.Chapter Two — General Commercial Law • oﬀeror/promisor—An oﬀeror or promissor is one of the parties to a contract. (i. • express contract—When the parties state their agreement orally or in writing. • executed performance—An executed performance contract has been fully performed by the contracting parties. oﬀer and acceptance—A contract is basically a manifestation of the parties’ mutual assent reached through an oﬀer and its acceptance.
• examining the addressee—The communication must suﬃciently identify the oﬀeree or the class from which the oﬀeree should emerge. • is rejected by the oﬀeree—Even if an oﬀer is open for a speciﬁed period of time. • is revoked by the oﬀeror—An oﬀer that is not irrevocable may be revoked by the oﬀeror any time before acceptance. Time is measured from the time the oﬀeree receives the oﬀer. a rejection will terminate the oﬀer. an application is the oﬀer and issuing an insurance policy is acceptance. First Element: An Offer and its Acceptance A conditional promise made by the oﬀeror to the oﬀeree is an oﬀer. legal capacity to consent—In order to bargain and reach agreement. • is terminated by operation of law—When an oﬀer is terminated by operation of law. A wri�en agreement is needed to form a contract for the sale of real estate but it is not necessary in most other contracts. The eﬀect of a counteroﬀer is to create a new oﬀer and to reject the original oﬀer. For example. No oﬀer exists if the addressee is an indeﬁnite group. Rejection terminates the oﬀer on receipt by the oﬀeror or his authorized agent. 82 . Indirect revocation occurs through some third party not associated with the oﬀeror and becomes eﬀective when the oﬀeree becomes aware of it. How to Determine Whether an Offer Was Made This requires: • evaluating the language used—An oﬀer requires words of present commitment or undertaking. The promise is conditional because the oﬀeror is not bound unless the oﬀeree (1) performs an act. (2) refrains from performing an act. Duration of A Properly Communicated Offer A properly communicated oﬀer continues in existence until it: • lapses or expires—If a deﬁnite expiration date is not stipulated. Events that by law terminate an oﬀer include: the death or adjudged insanity of either party. 4. or (3) promises to do something or refrain from doing something. An agreement is reached when the oﬀeree complies with the terms of the oﬀer within the proper time period. or illegality that occurs a�er the oﬀer is made. notice of this occurrence does not have to be given to the oﬀeree or oﬀeror. This revocation can be communicated to the oﬀeree either directly or indirectly. the oﬀer remains open for a reasonable time. A direct revocation is eﬀective when received by the oﬀeree. legal purpose—Contracts enforced by the law cannot conﬂict with the law or be at odds with public policy. • deﬁniteness of oﬀer—This allows a court to be reasonably certain regarding the nature and extent of assumed duties. even if the oﬀeror has promised to hold the oﬀer open for a deﬁnite period. parties must meet some basic level of competence and legal responsibility.Certiﬁed Bank Auditor Examination Review — Volume 7 3. the destruction of the subject ma�er of the oﬀer.
2. communicating a return promise to the oﬀeror (bilateral oﬀer).) Three elements must be present in the bargained-for exchange of consideration: 1. I promise to pay you $100” NOTE: Promises can be in diﬀerent forms. The promisee must suﬀer legal detriment. Some examples: Oﬀeror/Promisor: “I promise to pay you $100 if you promise to paint my fence” Oﬀeree / Promisee: “I agree. The oﬀer is then irrevocable for the time stated in the oﬀer or. The oﬀeror has the power to control both the manner (promise or performance) and mode or medium (phone. (See later sections.Chapter Two — General Commercial Law Irrevocable Offers An oﬀer may be irrevocable because: • it is an option contract—An option contract occurs when the oﬀeror sells his power to revoke to the oﬀeree. A promise may be exchanged for another promise. at least for a speciﬁed time. etc. for performance of an act. A merchant must sign a writing that the oﬀer will be held open. 3. Acceptance may take the form of performing an act (unilateral oﬀer). • of legislation—A merchant’s oﬀer is irrevocable without consideration.) of acceptance. a contract so one-sided that it is unconscionable may be unenforceable. or signing and delivering a wri�en instrument. 83 . • of the conduct of the oﬀeree—Once the oﬀeree starts to perform or relies on the oﬀer. telegram. if not stated. Keep in mind that while courts generally do not get involved in determining whether consideration is adequate. for a reasonable time. Note: The time for the oﬀer to be irrevocable cannot exceed three months. I promise to paint your fence” or Oﬀeror/Promisor: “I promise to paint your fence if you promise to pay me $100” Oﬀeree/Promisee: “I agree. The legal detriment must induce the making of the promise. mail. Second Element: Bargained-For Exchange of Consideration The contents of contracts are basically promises. The oﬀeree has obtained control of the revocability of the oﬀer. The promisor’s promise in question must induce the promisee’s legal detriment. • of acceptance—This includes any indication by the oﬀeree of his willingness to be bound by the terms of an oﬀer. the oﬀeror loses the power to revoke the oﬀer. A legal detriment can be a promise to perform an act that one had no prior legal obligation to perform. The oﬀeror (the promisor) says that he will do X if the oﬀeree (the promisee) will agree to do Y. Acceptance is eﬀective at the time it is dispatched. or for a forbearance of an act. An oﬀer can be accepted only by the person to whom it is made. It can also be to refrain from doing something that one could legally do and had no prior legal obligation not to do.
Certiﬁed Bank Auditor Examination Review — Volume 7
Defective Promises A promise may be defective because: • it is illusory—An illusory promise is a statement that purports to be a promise but is not because the promisor need not perform it. There must be a possibility that the promisor will incur legal determinant or the promise is illusory. • the promisee is already bound to do what he promises to do—This is called a preexisting duty. No legal determinant occurs when one promises to do what one is already legally obligated to do or promises to refrain from doing what one legally cannot do. • the promise is to forbear from suing, but the promisor has an invalid claim—Forbearance to assert an invalid claim is determinant if the claim is asserted in good faith and is not unreasonable. Promissory Estoppel The legal doctrine of promissory estoppel sometimes validates a promise even when bargained-for exchange of consideration is not present. Since there is no exchange of consideration, the promise isn’t actually a contract. The doctrine of promissory estoppel is the legal means used to enforce such promises almost as though they were contracts. If a promisor’s promise can be expected to induce a promisee to make a detrimental change in his position, then promissory estoppel forces the promisor to fulﬁll his promise. This is the law’s a�empt to provide equity (i.e., fairness). Third Element: Legal Capacity to Consent Minors (people below the age of majority, also called infants) and insane or intoxicated persons do not have the legal capacity to assent to contract terms. These parties can render an otherwise valid contract inoperative through the remedy of rescission. Insane Persons Legal capacity to contract refers to the mental state of a contracting party. A person cannot contract if he does not have a full understanding of his rights and does not have suﬃcient mental capacity to understand the nature, purpose and legal eﬀect of the contract. A party without mental capacity to contract and who has not been adjudicated insane can avoid a valid contract. However, if a person is legally declared insane, then there is no question, the contract is automatically void. If an insane person avoids a contract and the other party has treated him in good faith, then the insane person must return all consideration or beneﬁt received. If the other party has not acted in good faith or the contract is unconscionable, the incapacitated party has to return only what is le� of the consideration. Minors Any contracts made with a minor are voidable by that minor. However, only the minor may void the contract between himself and an adult—the adult is still obliged to the contract. The rights of minors in avoiding contracts vary from state to state. On the other hand, a minor remains liable on any contract until he actually takes steps to disaﬃrm the contract. A purely executory contract can be disaﬃrmed by directly informing the adult or by any conduct that clearly indicates the minor’s intent to disaﬃrm. If a
Chapter Two — General Commercial Law
minor disaﬃrms a contract, he can obtain return of his consideration or must return any consideration that he received from the other party. One modiﬁcation of the minor’s right to void his contracts involves necessities. Necessities are items needed for a minor’s subsistence as measured by age, station in life and any surrounding circumstances. Necessities include items such as medical services, education, food and lodging, and clothing. A minor is liable in a quasi contract for any of these necessities. Quasi-contract liability The two signiﬁcant features of a quasi-contract liability are: 1. The liability is for the reasonable value of the necessities, not the contract price. 2. The liability exists only for necessaries actually furnished, not on executory contracts. Note: Most state statutes do not allow minors to avoid contracts dealing with the purchase of life insurance or between the minor and a university. Some states do not allow married or emancipated minors to avoid contracts. Fourth Element: Legal Purpose A contract without a legal purpose is unenforceable. A contract or provision of a contract is illegal if it is prohibited by statute, violates the rule of common law or is contrary to public policy. Contrary to public policy means that the contract is injurious to public interests; violates some established interest of society; contravenes the purpose of a statute; or interferes with the public health, safety, morals or general welfare. In an illegal-contract case, the court typically leaves the parties as they are. Relief may be granted to a party to an illegal contract in the following three situations: 1. If a party is one of those people for whose protection the contract was made illegal, he may obtain restoration of what was paid or parted with or maybe even a legal remedy. 2. If a party is induced by fraud or duress to enter into an illegal agreement, the party is allowed restitution of what he has rendered by way of performance. 3. If a person repents before performing any illegal part of the contract, he may rescind the contract and obtain restitution for any past performance. This doctrine is called locus poenitentiae meaning a place for repentance. This doctrine operates within very strict limits. Violating Statutes Agreements that violate statutes include: • violations of license requirements—Certain professionals are required to be licensed by the appropriate body before they can contract with the general public. If the person is not properly licensed, the contract for the services is unenforceable. Frequently, the person receiving the service can refuse to pay the performing party. • usury—The amount of interest that may be charged on borrowed funds is limited by state statute. If a lender’s contract a�empts to receive more than the maximum interest, the civil penalty in most states denies the lender the right to collect any interest. Criminal penalties are also involved in charging illegal interest.
Certiﬁed Bank Auditor Examination Review — Volume 7
• contracts, agreements and activities in restraint of trade—Antitrust laws were established to protect the U.S. economic system from monopolies, a�empts to monopolize and activities that restrain trade. The Sherman Act provides three basic sanctions to prevent restraint of trade: 1. federal felony charges punished by ﬁne (payable to the government), imprisonment or both. 2. government injunctions to prevent and restrain future or continued acts in violations of the act. 3. collection by the plaintiﬀ of treble damages plus court costs and reasonable a�orney’s fees Violating Public Policy Agreements that violate public policy include: • agreements not to compete—An agreement not to compete restrains trade. Agreements not to compete are commonly found in a contract for the sale of a business, in a contract creating a business or professional practice or in an employment contract. Such an agreement may be enforced unless the court determines that it is unreasonable to one or both parties or to the general public. • contracts of adhesion and unconscionability—A contract of adhesion is a standardized contract entirely prepared by one party. The standardized items are submi�ed to the other party on a take it or leave it basis. These contracts are policed using the equitable principle of unconscionability. Unconscionability is determined by a judge. Making a Valid Contract: Formality or Writing Requirements If the four elements described above are present, the contract will be valid. However, making the contract enforceable can require certain formalities. The Statute of Frauds The statute of frauds requires that certain types of contracts must be in writing to be enforced, including the following: • guaranty contracts—A guaranty contract occurs when a party agrees to guarantee the debt of another. The guarantor is secondarily liable on the debt. This type of contract must be in writing when its main purpose of guaranteeing the debt is to beneﬁt the debtor. • contracts involving real estate—Any contract creating or transferring an interest in land requires a writing. • contracts of long duration—A contract that cannot possibly be performed within one year from the time it is made must be in writing. This period is measured from the time an oral agreement is made to the time when the promised performance is to be completed. • contracts for the sale of goods—A contract for the sale of goods for an amount of $500 or more requires a writing. Several provisions of the code relate to the statute of frauds. • contracts for the sale of personal property other than goods—A writing is required for a contract involving the sale of securities, the sale of personal property other than goods or securities if the amount exceeds $5,000, or a secured transaction. The statute of frauds requires only a note or memorandum that provides wri�en evidence of the transaction. This writing must be signed by the party seeking to be bound by the
• specially manufactured goods—To ﬁt into this category the goods must be specially manufactured for the particular buyer and be unsuitable for sale to others. Exceptions Exceptions to the Parol Evidence Rule include: • oral evidence to establish modiﬁcations agreed upon a�er execution of the wri�en contract • evidence that the agreement has been canceled • evidence of fraudulent misrepresentation • lack of delivery of an instrument when delivery is required to give it eﬀect • errors in pu�ing the contract into writing • the partial integration rule 87 . The statute of frauds requires that the performance must establish existence of an oral contract and must be substantial enough to warrant judicial relief such as speciﬁc performance of the oral contract. In addition. he must give wri�en notice within ten days a�er receipt. a description of the subject ma�er (real estate must be described with certainty). The Parol Evidence Rule The Parol Evidence Rule provides that statements. • judicial admissions—An admission of the existence of the contract by the party resisting the contract will substitute for a writing. Code exceptions to the statute of frauds include: • wri�en conﬁrmation between merchants—If a merchant contracts orally with another merchant. Exceptions to the Statute of Frauds Common law exceptions to the statute of frauds are: • equitable estoppel or part performance—Equitable estoppel stops one party in an oral contract from using the statute of frauds as a defense when the other party partly or fully performs. and the circumstances must reasonably indicate that the goods are for the buyer. Promissory estoppel can be used to prevent an unfair use of the statute of frauds. It prohibits the introduction of subsequent evidence that would alter a wri�en contract. promises and representations made by the parties prior to signing the wri�en contract may not be considered. understandings.Chapter Two — General Commercial Law agreement (the defendant). • promissory estoppel—An oral promise may be enforceable if a party relies on it to his detriment. This admission is typically made by the defendant during court proceedings. or the seller has shipped goods which the buyer accepted. This contract is enforceable even though the conﬁrmation is not signed by the person to be charged. representations and agreements. the price and the general terms of the agreement. the seller must have made a substantial beginning to manufacture or commitments to obtain the goods. It should also include the names of the parties. • part performance—Contracts are enforceable to the extent that the buyer has made payment for goods. The theory is that the wri�en contract integrates all prior negotiations. If the merchant receiving the writing objects to its contents. he can satisfy the statute of frauds by sending a conﬁrming writing to the other merchant.
A bona ﬁde. a tender is the presentation of performance. In resolving any inconsistencies in contract terms. A person who makes a tender is ready. 88 . a party can reply to these charges by saying that he had an inability to perform. Interest stops accruing at the date of tender. he can oﬀer the defense of inability to perform. he is said to be in breach of contract and will be liable for certain damages. Voiding the Contract Ideally. Contract Breach. Most contracts require that one of the contracting parties tender payment to the other. the case with most contracts. In other cases. one of the parties does not perform and is considered to be in breach of the contract. in fact. by usage of trade. Any security interest in property belonging to the debtor would be extinguished. express terms prevail over an interpretation based on course of performance. Instead of being on the defensive. 2. All of these conditions are discussed below. Satisfactory Performance of the Promise as Contracted: Tender In the law of contracts. Inability to Perform If a party is charged with breach of contract. However. willing and able to perform the promise as it was contracted. and course of performance prevails over an interpretation based on course of dealing or usage of trade. A party being accused of breach of contract will frequently oﬀer the defense that the contract is not valid and should be voided. on occasion a party will seek to void a contract proactively rather than be forced to perform or wait for conditions that might qualify as a breach.Certiﬁed Bank Auditor Examination Review — Volume 7 Note: The partial integration rule is deﬁned as follows: If the parties intend the writing to be ﬁnal on the terms as wri�en but not necessarily complete on all terms of the agreement. Legal Effects of Tender Suppose A tenders payment to B who refuses to accept the tender. If a party is charged with either of these. This is. If tender was proper. he must pay the court costs. If the creditor later brings legal action and recovers only the amount tendered. The End of the Contract: Satisfactory Performance. every contract would be performed by the parties and they would go away satisﬁed. Contract Breach There are two terms used when a contract is breached: refusal to perform or failure to perform. 3. • evidence which clariﬁes a contract ambiguity • evidence which a�acks the legal validity of a contract • any agreement a�er the writing that is signed by both parties The code allows wri�en contracts to be explained or supplemented by a prior course of dealing between the buyer and seller. unconditional presentation of payment along with actual production of the money or its equivalent must be made. or by course of performance. the valid tender has the following three important legal eﬀects: 1.
The injured party still has his remedies which were available at the time of performance. it is not wri�en in the contract but is read into the contract in the interest of good faith and fair dealing. One party’s performance of a constructive condition triggers the other party’s duty to start performing his side of the bargain. destruction of any subject ma�er essential to the completion of the contract d.Chapter Two — General Commercial Law This sometimes excuses his breach and therefore relieves him of liability. Retraction of a waiver may occur unless it is supported by consideration or the promise has substantially changed his position in reliance on the waiver. an essential element is missing at the time the contract is made • commercial frustration—The doctrine of commercial frustration excuses performance when the essential purpose and/or object of the contract cannot be reached. • impossibility—Impossibility requires that performance be physically and objectively impossible. An express repudiation is a clear. Refusal to Perform or Repudiation Anticipatory repudiation occurs before performance is due and may be express or implied. A waiver issued before a breach assures the other party that performance of the condition is not required. Nonrepudiating Party’s Remedies The nonrepudiating party has several remedies to choose from: • Treat the repudiation as an anticipatory breach and immediately seek damages for breach of contract. • Treat the contract as still in force. A constructive condition is part of the detailed interaction between two parties who have contracted. positive. This nulliﬁes the repudiation. An implied repudiation occurs when the promisor makes it impossible for himself to perform. Impossibility may take one of the following forms: a. An express or constructive condition may be legally excused in one of the following ways: • hindrance. • Wait until the time for performance and if the other party does breach. prevention and noncooperation—If one party to a contract makes it impossible for the other party to perform. enactment of a law or governmental action that makes performance illegal b. then exercise the remedies for actual breach. unequivocal refusal to perform. the death or disabling illness of one of the contracting parties c. 89 . a contract to excavate a basement may naturally require (but not necessarily in writing) that one party remove the trees before the other party can do the excavating. • waiver—Waiver means either (1) a promise to relinquish the beneﬁt of a condition to the promisor duty or (2) the decision to continue under a contract a�er the other party has breached. Inability to Perform a Constructive Condition An express or constructive condition may create a situation where a party has an inability to perform. Waiver may occur before or a�er a breach. then nonperformance on the part of the other party is excused. If one party breaches a contract because the other party has been uncooperative. the uncooperative party is not entitled to the usual contract remedies. Actual impossibility discharges both parties from their duty to perform. A constructive condition is an implied-in-law condition. For example.
e. First. In this case the excavator is still expected to perform his side of the deal. In addition. doing a very poor job) can be a breach. when one party removes the trees but leaves some small saplings and bushes. as with inability to perform. for example. omission or error arising from surprise. the injured party must have placed a justiﬁable reliance on the false statement or concealment. Note: Innocent misrepresentation requires proof of all of the above elements except scienter. 90 . the court may grant either a contract correction or avoidance of the contract. Fraud. In both cases the victim may avoid the contract. Fraud and Misrepresentation If one party to a contract misrepresents a material fact.Certiﬁed Bank Auditor Examination Review — Volume 7 A party may retract his repudiation as long as the other party has not materially changed his position in reliance upon the repudiation. may be awarded to the nonbreaching party. An example of a substantially performed constructive condition is. A mistake is an unintended act. However. an unintentional misrepresentation is an innocent misrepresentation. the other party will need to have a basis for declaring the contract void. Third. there must be a false representation or the concealment of a material fact. mistake and duress are three common grounds for voiding a contract.) Constructive conditions that have been poorly performed (or not performed at all) are a material breach of contract. Failure to read the contract is sometimes a�empted. (See above. then the other contracting party may void the contract. In addition. Voiding a Contract If one party is insisting that the other party honor an enforceable contract. failure to perform (i. The nonbreaching party may then choose to either rescind the contract and sue for damages or continue the contract and sue for damages. but this rarely works to void a contract. Failure to Perform Similar to refusal to perform. if anything. but if the misrepresentation is fraudulent the victim may also sue for dollar damages. there must be scienter—the intention to mislead. This refers to knowledge by a defrauding party that his representation is false. Some constructive conditions have been substantially (yet imperfectly) performed and are an immaterial breach. the excavator cannot use this as an excuse to end the contract. failure to perform can include constructive conditions. Mistake In the case of a mistake. the nonbreaching party still has the duty to perform. Second. The excavator can ask the other party for the extra costs related to the saplings and bushes. Fourth. In these cases only monetary damages. imposition. Determining Fraud To determine if a misrepresentation is fraudulent several elements must exist.. damage must have resulted as a result of reliance on the misrepresentation. An intentional misrepresentation is fraud. Retraction requires only that the party give notice that he will perform a�er all.
speciﬁc performance. an oﬀeree who is aware of the oﬀeror’s mistake cannot accept the oﬀer and proﬁt from it. Deﬁnitions • money damages—Money damages may be nominal damages. Remedies: The Courts’ Response to Breached or Voided Contracts Money damages. consequential damages. • nominal damages—If the nonbreaching party suﬀers no compensable loss or fails to prove the amount of loss. foreseeable result of a breach of contract—not a rare or ﬂuke outcome of the breach. A unilateral mistake occurs when only one contracting party labors under a mistake. If a bilateral mistake has a material eﬀect on the agreed exchange of performances. Equitable remedies are allowed only if the remedy of money damages is not adequate under the circumstances. 2. Nominal damages are typically one dollar and symbolize the wrong done by the mere breach of contract. 91 . Speciﬁc performance. In addition. rescission and restitution are called equitable remedies. Of course. A bilateral mistake refers to an identical mistake on the part of both contracting parties. then relief is appropriate. The only remedy in such a case is rescission. Undue inﬂuence is a subtle pressure whereby one party overpowers the will of another through the use of moral. Typically a party must elect one of these remedies to the exclusion of the others. Duress and Undue Inﬂuence A party who agrees to a contract under duress or undue inﬂuence may rescind the agreement. He was prevented from reading the contract by a misrepresentation on the part of the other party. The two parties involved had a ﬁduciary or conﬁdential relationship which was relied upon in not reading the contract. social or domestic force. punitive damages or liquidated damages. the injured party must take reasonable steps to reduce the actual loss to a minimum. Therefore a person who signs a contract without reading it is still bound by the contract unless he can show that: 1. An emergency existed at the time of signing that excused the failure to read. The mistaken party is not usually granted relief. The court will grant relief only if the mistake is material and genuine consent is not present. he can only recover nominal damages. A mistake may be bilateral or unilateral. • compensatory (or general) damages—Compensatory damages are designed to compensate the aggrieved party for his loss.Chapter Two — General Commercial Law ignorance or misplaced conﬁdence. 3. Failure to Read the Contract Failure to read the contract is rarely considered suﬃcient reason to void because a person who signs a wri�en contract is presumed to know the contents of the document. The injured party should be placed in the same position he would have occupied had the breach not occurred. Duress is a loss of free will due to some threat. These damages must be a direct. compensatory damages. rescission and restitution are the four basic remedies in contract law.
Forms of Contract Discharge If a contract is discharged. consideration or proof of gi� is required. something diﬀerent than what the original contract stated. (In this case.e. it is called restitution.) • There is a legal excuse from a contract performance. • restitution—When the court requires a party who has been unjustly enriched to return an unfairly gained item or its value. Rescission may be used when a transaction is induced by fraud or mistake. it is called rescission.) 92 . the nonbreaching party may have to pay for the beneﬁt. the recipient must either return the beneﬁt or pay for its reasonable value whether the breach is willful or unintentional. • speciﬁc performance—When the court requires the breaching party to do exactly what he agreed to do under the contract. A party who discovers facts that warrant rescission must do so within a reasonable time.Certiﬁed Bank Auditor Examination Review — Volume 7 Note: If a contract is willfully and substantially breached a�er part performance has occurred. • There is a voluntary renouncement or waiver by one party. accord and satisfaction: Accord is an agreement whereby one party undertakes to perform. (In this case. no consideration is required. • consequential (or special) damages—Consequential damages arise from special circumstances surrounding a contract and are not normally foreseeable. Satisfaction means that the substituted performance is completed.) • There is cancellation of a wri�en contract and surrender by one party to the other. They are also awarded to deter others from the same conduct in the future. or when a breach is so substantial that the other party should not be required to perform. Discharge may occur in one of the following ways: • Both parties complete the performance of their obligations as speciﬁed under the contract. • liquidated damages—Liquidated damages are stated within the contract as the money damages applicable in the case of a breach. it is called speciﬁc performance. The amount stated must bear a reasonable relation to the probable damage to be sustained by the breach. evidence must be submi�ed that proves the breaching party knew that special circumstances existed and that these special circumstances would cause the other party to suﬀer additional losses in the case of a breach. and the other to accept. Punitive damages are most o�en awarded when the breach is fraudulent. To recover these damages. If the breach is unintentional. • There is a rescission of the contract. If the nature of the beneﬁt is such that it can be returned. This remedy is used in contracts where the subject ma�er is unique. • rescission—When the court disaﬃrms the contract and restores the parties to the position they occupied before making the contract.. however. • The parties work out an acceptable substitute to the original promised performances. This is used in cases where the only adequate remedy may be to require the breaching party to perform the contract. when a minor wishes to withdraw from a contract. • punitive (or exemplary) damages—Punitive damages are awarded to one party in order to punish the other’s conduct. (i. if the nature of the beneﬁt is such that it cannot be returned. oppressive or malicious. it is canceled and enforcement of its provisions is terminated. such as contracts involving real estate and personal property. the nonbreaching party does not have to pay for the beneﬁt.
new party—The new party must agree to assume the burdens and duties of the withdrawing party. • assignment—When a party to a contract (assignor) transfers to a third party (assignee) his rights under the contract. An eﬀective novation requires agreement by the following parties: 1. • third-party beneﬁciary—When one party contracts with a second party for the purpose of conferring a beneﬁt upon a third party. • One of the parties enters bankruptcy. the liability of the assignor is determined by the reason for the assignment. (See below for a deﬁnition. the dismissed party is no longer liable. • There is a breach. Novation and Assignment Besides the two contracting parties. since all parties did not consent. A third party beneﬁciary cannot enforce a contract unless the terms of the contract clearly indicate intent to beneﬁt the third party. If a third party’s beneﬁt is only incidental to the contract. There are two types of third-party beneﬁciaries: donee-beneﬁciaries or creditor-beneﬁciaries. (See below for a deﬁnition.Chapter Two — General Commercial Law • Parties to a contract may substitute a new debt or obligation for an existing one or replace an original party to the contract with a new party. A�er assignment. it is an assignment. If the assignment is security for a debt owed to the assignee by the assignor. 2. a new contract is formed and the original contract is discharged.) Third-Party Roles in Contracts: Beneﬁciaries. Most states require the beneﬁciary’s consent to rescind a contract a�er the beneﬁciary has accepted its terms. however. in an assignment contract one party may assign rights without the consent of the other contracting party. another party o�en becomes involved either because it is beneﬁted by the promises between the two contracting parties or because it stands in the place of one of the contracting parties. Unlike a novation. Since all parties consent to the substitution in a novation. remaining contracting party—The remaining contracting party must agree to accept the new party and release the withdrawing party. he cannot sue. but not an assignment. • Time passes without litigation to enforce one's rights. 93 . Furthermore. the assignor has given up all interest in the contract rights. 3. the assignor still remains ultimately responsible for any duties that were transferred should the new party fail to perform them.) • The actual obligation is surrendered or destroyed (as with a negotiable instrument). Both types may enforce a contract made on his behalf. this person is the third-party beneﬁciary. Assignment of Claims An assignment of claims for money due or to become due under existing contracts is valid. • donee-beneﬁciary—A donee-beneﬁciary is a third party for whom the promisee purchased the promise as a gi�. This is called novation. withdrawing party—The withdrawing party must consent to withdraw and allow the new party to take his place. If the debtor-obligor defaults. In essence. • novation—A novation is an agreement whereby all concerned agree to substitute a new party for one of the original parties to a contract. • creditor-beneﬁciary—A creditor-beneﬁciary is a third party for whom the promisee has contracted for a promise to pay a debt.
he may perform for the original contracting party (the assignor). If the assignment is a purchase of a debt. the assignee owns the rights to a contract and is entitled to receive them. the assignor typically does not have to pay. an assignment of an entire contract carries an implied assumption of liabilities. the assignee cannot demand performance from the obligor. The assignor would have to pay only if the claim was sold with recourse. This will determine whether only the rights are assigned or both the rights and the duties. 94 . The prospective assignee can feel free to accept the assignment if neither he nor the debtor is aware of a previous assignment. An obligor who has received notice must perform for the assignee. Assignment Liability A�er assignment. The assignee should notify the debtor-obligor of the assignment because: • If the obligor does not know of the assignment. the assignor who receives performance under these circumstances can be forced to turn over any funds or property received from the obligor to the assignee. and (3) there are no valid defenses to the claim. 3. For this reason. If the assignee fails to perform. Therefore. However. • Notiﬁcation protects innocent third parties. the ﬁrst assignee to give notice to the debtor will prevail over another assignee. the obligor can assert the same defenses against the assignee that are available against the assignor. However. 2. The assignor has the power. If the obligor performs for the original party (the assignor). On assignment. to make a second assignment.Certiﬁed Bank Auditor Examination Review — Volume 7 the assignor must pay the assignee. The assignor must pay the assignee if any of these warranties are breached. The liability of the assignee to third parties is made by studying the transaction. and any performance to the assignor would not relieve him of his obligation to the assignee. but not the right. he should give prompt notiﬁcation to the debtor. the assignor warrants that (1) the claim is a valid legal claim. a party considering an assignment should communicate with the debtor to conﬁrm that the right has not been previously assigned. In these cases. A general assignment of a contract that calls for the performance of aﬃrmative duties by the assignor does not impose those duties on the assignee. skills. conﬁdences. knowledge or experience. Since an assignee stands in the shoes of the assignor. (2) the debtor-obligor is legally obligated to pay. A contract that would place an additional burden or risk on one of the parties cannot be assigned without consent. On assignment. Typically. Contracts involving personal rights or personal duties may not be assigned. A party who has the right to purchase goods on credit may not assign this right to a third party unless the seller has security for payment. the contract performance includes personal trust. the contract is not discharged. Exceptions to Assignment Exceptions to the general rules pertaining to assignment are as follows: 1. such contracts cannot be assigned by one party without the consent of the other contracting party. the obligee can sue either the assignor or the assignee. Therefore.
Bankruptcy Deﬁnitions • bankruptcy—legal process by which a debtor’s property and debts are resolved • debtor—entity to which the bankruptcy case pertains • creditor—entity to whom the debtor owes money • claim—a debt or right to payment from the debtor that is held and asserted by the creditor. The goal of bankruptcy is to fairly resolve a debtor’s ﬁnances which have go�en out of control. If the clause makes an assignment void. bankruptcy is a reorganization/rehabilitation opportunity for the debtor so that he may regain mastery over his aﬀairs (as in Chapter 11 and 13). Chapter 7 bankruptcies are more severe and require liquidation. then a court’s order of relief is issued which authorizes the actual bankruptcy process. but the obligor can avoid the contract for breach of the promise. the selling of assets and the payment of creditors • trustee—person responsible for managing the debtor’s assets • estate—the pool of the property which is the source used to satisfy creditors • insider—the debtor’s relatives. Once bankruptcy proceedings start. • unimpaired claim—a debt that is essentially unchanged by the bankruptcy proceedings. assignment would be eﬀective. bankruptcy may be the answer. If the clause prohibits assignments. corporation or municipality has trouble paying its debts. • impaired claim—a debt that the bankruptcy proceedings either decrease or delay. These are then either paid in full. creditors are prohibited from a�empting to collect their debts and are expected to work through the proceeding for any payments. delayed or sometimes eliminated. but a promise not to assign is created. partnership. Bankruptcy is an ancient law that has been in existence since the Roman Empire. no party has the power to assign. • order of relief—court order from the bankruptcy judge (when he decides that the debtor is entitled to bankruptcy law protection) authorizing the bankruptcy. SECTION 2. partners. reduced. the trustee’s actions. b. the debtor’s property is channeled to his debts. 95 . As a result of bankruptcy. Therefore. • secured debt—a debt which is accompanied by giving the creditor an interest in property.Chapter Two — General Commercial Law Antiassignment An antiassignment clause may be included in a contract. Types of Bankruptcy In some cases.7: BANKRUPTCY Scope When a person. an assignment would be eﬀective. The language of an antiassignment clause determines how the court will interpret the clause: a. the promisor has the power to assign. c. but the obligor has a legal claim against the assignor for breach of his promise not to assign. or (if debtor is a corporation) directors or executives. All bankruptcies start with a petition. If the clause invalidates the contract.
Certiﬁed Bank Auditor Examination Review — Volume 7
Five types of bankruptcy proceedings are identiﬁed by their chapter in the bankruptcy statute: 1. Chapter 7 - Liquidation 2. Chapter 9 - Adjustment of Debts of a Municipality 3. Chapter 11 - Reorganization 4. Chapter 12 - Reorganization for Farmers 5. Chapter 13 - Adjustment of Debts of an Individual with Regular Income Chapter 7 involves liquidation which eliminates most of a debtor’s debts. The creditors’ claims are se�led using most of the debtor’s assets. Chapter 7 is the more drastic debt remedy in that the debtor loses most of his property and retains li�le control over the administration of the process. The debtor’s role is passive—a trustee makes a plan and then gathers the assets, converts them to cash and provides for any payments to creditors. In Chapter 7, not all debts are paid in full and many are not paid at all. Discharge relieves the debtor of the remainder of any debts that arose prior to the order of relief and still remain a�er distribution of the debtor’s property. A discharge of any remaining debt is not guaranteed, however it is frequently granted to individuals. Chapter 7 is available to individuals, partnerships or corporations. It is not used by railroads, insurance companies, banks, savings and loan associations, homestead associations and credit unions. Stockbrokers and commodity brokers can only ﬁle under Chapter 7 (not the other chapters), since large indebtedness and substantial assets are involved. Because of this, Chapter 7 includes special provisions for stockbrokers and commodity brokers. Chapter 9 applies to insolvent municipalities only and is not applicable to the CBA exam. Chapter 11 is used when a debtor wishes to restructure his ﬁnances and a�empt to pay creditors over an extended time period. A commi�ee consisting of some of the debtor’s creditors is appointed by the court to represent the creditors’ interests. The commi�ee of creditors helps the debtor in preparing a reorganization plan. A trustee is typically appointed prior to the approval of the debtor’s reorganization plan. The trustee investigates the relevant aspects of the debtor and ﬁles a wri�en report with the court. As with Chapter 7, Chapter 11 is available only to individuals, partnerships or corporations. However, unlike Chapter 7, the Chapter 11 debtor stays in charge and retains ownership of his assets. In Chapter 11 reorganization proceedings, the debtor ﬁles a reorganization plan with the court. This plan classiﬁes claims. The plan speciﬁes the treatment of impaired claims and denotes the unimpaired classes of claims. The plan provides a means for its execution and deals with all aspects of the organization of the debtor and its property and debts. It is required that all claimants receive as much as they would have otherwise received in liquidation proceedings. Those holding an interest in the debtor’s property vote to either accept or reject the proposed plan of reorganization. A hearing is held to determine whether the plan is fair and equitable. Once the plan is conﬁrmed, it is binding on the debtor, equity security holders and creditors. Chapter 12 is a new chapter of the U.S. Bankruptcy Code and was signed into law in
Chapter Two — General Commercial Law
November 1986. It is speciﬁcally designed for family farmers, because certain disclosure requirements and timetables of other bankruptcy codes were considered unworkable for them. To be eligible, a farmer cannot be more than $1.5 million in debt and $800,000 of that debt must come from farming. Chapter 12 also requires that at least half of the farmer’s gross income for the year before ﬁling bankruptcy must come from the farm. Chapter 12 shields the farmer from creditors and allows him to continue farming. The reorganization period is only 90 days, much less than other bankruptcy proceedings. Under Chapter 12, the farmer may sell some land on which a creditor has a lien without the creditor’s approval. An additional way Chapter 12 is unlike other bankruptcy proceedings is that creditors in these cases are not allowed to ﬁle their own competing reorganization plans for the indebted farmer. Chapter 13 proceedings are used when an individual has small debts and a regular income signiﬁcant enough that substantial repayment is feasible. With Chapter 13 the individual’s unsecured debts cannot exceed $100,000 and secured debts cannot exceed $350,000. Repayment preference in a personal bankruptcy is given to a creditor with a secured interest in property. The debtor retains possession of his property and his income is used to pay debts. The trustee controls and supervises the debtor’s income. The plan of adjustment of debts is conﬁrmed if the court is satisﬁed that (1) the plan is proposed in good faith, (2) it is in compliance with the law, (3) it is in the best interest of the creditors, and (4) the debtor can make the payments the plan speciﬁes. Starting the Bankruptcy Proceedings: Voluntary and Involuntary Voluntary bankruptcy proceedings are started by the debtor. A husband and wife may instigate a joint case. This requires only one petition but both signatures. The petition includes a bankruptcy schedule which lists the debtor’s secured and unsecured creditors, all of his property, any property he claims is exempt and is a statement of the debtor’s aﬀairs. A voluntary petition acts as an automatic order of relief and gives the debtor protection by the bankruptcy court. Once the bankruptcy judge decides the petition was properly ﬁled and an order of relief is eﬀective, an interim trustee is appointed. An involuntary bankruptcy case is started when one or more of a debtor’s creditors ﬁles a petition. If the debtor has twelve or more creditors, the petition must be signed by at least three whose unsecured claims are not contingent and aggregate at least $5,000. If the debtor has fewer than twelve creditors, the petition must be signed by only one of them, but the $5,000 amount must still be met. The debtor may ﬁle an answer to the creditors’ petition in which he can deny any or all allegations. When an answer is ﬁled, a trial is conducted based on the issues raised by the creditors’ petition and the debtor’s answer. If it is determined that the debtor is not paying his debts as they become due (or if the debtor does not answer the petition), relief is granted to the creditors and against the debtor. At that point, the debtor must still complete the same schedules as a debtor in a voluntary proceeding. Note: Certain debtors are not subject to involuntary proceedings. Creditors are prohibited from commencing involuntary proceedings against farmers or not-for-proﬁt corporations under either Chapter 7 or 11. Also, involuntary proceedings cannot be commenced against any debtor under Chapter 13.
Certiﬁed Bank Auditor Examination Review — Volume 7
The Bankruptcy Process The following sections discuss stages of the bankruptcy process: Property Included and Exempted Debts Included and Exempted Trustee’s Duties and Powers Reviewing Debtor’s Past Payments and Transfers Allowing Creditor’s Claims Prioritizing and Paying Creditor’s Claims Discharge Property Exempted from Bankruptcy The bankruptcy laws were enacted to give debtors who were in a tough ﬁnancial situation a chance to start over. Almost all of the debtor’s assets become part of the bankruptcy estate from which the creditors are paid. The estate initially includes all legal or equitable property interests of the debtor. However, in order that the debtor will have some assets with which to start over, certain items are exempt. Exempt property cannot be recovered and required for use in paying the debts that arose prior to commencement of the bankruptcy case. The exemptions are as follows: • the debtor's interest in real property used as a residence—up to $7,500 • the debtor's interest in a motor vehicle—up to $1,200 • the debtor's interest in furnishings, clothes, appliances, books, animals, crops, etc, that are primarily held for the personal use of the debtor and his dependents—up to $200 a particular item, or $4,000 in aggregate value • the debtors' interest in jewelry—up to $500 • the debtor's interest in other property—up to $400, plus up to $3,750 of any unused real property exemption • the debtor's interest in any implements, professional books, or tools of the debtor's (or his dependents') trade • professionally prescribed health aids • unmatured life insurance contracts • the cash value of life insurance—up to $4,000 • the debtor's right to payments from social security, unemployment compensation, alimony, etc. (as reasonably necessary), and payments from pension or other similar plans • the debtor's right to receive life insurance policy proceeds on the life of someone on whom the debtor was dependent—up to $7,500 • personal injury payments—up to $7,500 Note: Remember that federal and state laws vary and they inﬂuence the amounts and types of exemptions. Debts Exempted from Bankruptcy In bankruptcy, almost all of the debtor’s debts are eligible for potential reduction or even
the creditors elect a permanent trustee. The following are the duties as deﬁned by law of a trustee in liquidation (Chapter 7) proceedings: • investigate the debtor's ﬁnancial aﬀairs including his (possibly fraudulent) past ﬁnancial transactions. This meeting allows the creditors to question the debtor under oath and to examine ma�ers that may aﬀect the right of the debtor to have his obligations discharged. During the proceedings. certain debts cannot be discharged in bankruptcy and the debtor remains obliged for them. Trustees’ Duties Trustees represent the estate and have the capacity to sue and to be sued. voluntary and involuntary proceedings are the same. and a date for a meeting of the creditors and the debtor. Notiﬁcation of the order of relief is given to all parties. Typically. payments or property transfers • furnish any information requested by a party in interest • if a business is operated: ﬁle appropriate reports with the court and taxing authorities • account for all property received • oppose the debtor's discharge (if advisable) • examine proofs of claim and object to the allowance of any improper claim • collect and reduce to money the estate's property 99 . the trustee is responsible for ﬁling the estate tax returns. child support and separate maintenance • debts for fraud or defalcation while acting as a ﬁduciary or created by embezzlement or larceny • liability for willful and malicious torts • certain taxes and custom duties • tax penalties if the tax is not dischargeable Trustee’s Duties and Powers Continuing from the point where the court issues an order of relief. They are: • consumer debts over $500 for luxury goods or services incurred within the last 40 days before the order of relief • unscheduled debts • debts owed prior to a previous bankruptcy to which discharge was denied on grounds other than the six-year rule. services. However. credit or money through false pretenses. • debts incurred in obtaining property.Chapter Two — General Commercial Law discharge. If the meeting is related to a liquidation case.000 within twenty days of the order of relief • alimony. Notiﬁcation to creditors includes the date by which all claims must be ﬁled. misrepresentation or actual fraud • student loans if the loan is less than ﬁve years old • debts incurred as a result of an accident caused by driving under the inﬂuence • cash advances granted under a consumer credit plan and for an amount greater than $1. trustees have the authority to hire any necessary professionals such as accountants or a�orneys and to invest or deposit the estate money.
. The trustee investigates to see if the debtor has funneled more money to one creditor to the detriment of the others. the law allows the trustee to recover the property and put it back into the bankruptcy estate where it can be distributed properly. The trustee is on alert to see if the debtor has ﬁled bankruptcy in bad faith. the trustee has a less active role and the debtor retains more control of the property.e. any transfers that show partiality to one creditor over another can be recovered by the trustee. as if he were a creditor • the rights and powers of a judgment creditor who obtained a judgment against the debtor on the date the bankruptcy was adjudicated and who had an execution issued that was returned unsatisﬁed • the right of a bona ﬁde purchaser of the debtor's real property as of the petition date • the rights of an actual unsecured creditor to avoid any transfer of the debtor's property and to avoid any obligation incurred by the debtor that is voidable under federal or state statute • the power to avoid certain liens of others on the debtor's property Reviewing Debtor’s Past Payments and Transfers In Chapter 7 liquidation proceedings. (i. Since the trustee is an advocate for all creditors he also is looking for signs of the debtor’s unfair preference of one creditor over the others. He is trying to escape his debts by hiding money with his friends or family. • The transfer must have provided the debtor with a greater percentage of his claim than he would have received under a distribution from the bankruptcy estate in a liquidation proceeding.) The trustee does this by looking over the debtor’s past dealings to make sure there were no shady deals designed to hide funds. • The transfer must have been made to a creditor to whom a debt was owed before the transfer. Conditions for a Recoverable Preference The following conditions must be met to constitute a recoverable preference: • An insolvent debtor must have made the transfer.Certiﬁed Bank Auditor Examination Review — Volume 7 • make a ﬁnal report and ﬁle it with the court Note: In Chapter 11 and 13 reorganization proceedings. 100 . Therefore. Trustees’ Powers The trustee’s rights and powers with respect to the debtor’s property include: • a judicial lien on the property. If the trustee does ﬁnd a questionable past property transfer (either to hide money or to funnel money). • The transfer must have occurred within 90 days of the bankruptcy petition ﬁling. Preferences in Debtor’s Past Payments One aim of bankruptcy proceedings is to equally distribute a debtor’s property among his creditors. the trustee acts as an advocate for all of the creditors.
creditors must ﬁle a proof of their claims.e. Prioritizing and Paying Creditor’s Claims Priority Claimants The general order in which priority claimants should be paid: 1. cannot be recovered: • payment of tax liabilities • payment of fully secured claims • payments in the ordinary course of business or the ordinary ﬁnancial aﬀairs of people not in business (i. • It is for rent not yet due. administrative expense claims 2. • It is for unmatured alimony or child support. payment of utility bills) Debtor’s Past Transfers of Property: Hiding property Some debtors try to hide assets by transferring them to others.Chapter Two — General Commercial Law Payments Not Considered Preferences The following payments are not considered preferences and. Disallowed Claims A claim may be disallowed if it meets any of the following criteria: • It is unenforceable because of usury. • It is paid to an insider or a�orney and exceeds the reasonable value of the rendered services. therefore. whereupon the court conducts a hearing to determine the claim’s validity. claims of persons who extend credit to the estate a�er the ﬁling of a Chapter 11 involuntary petition and before a trustee is appointed or before the order for relief is entered 101 . Filed claims are allowed unless an objection is ﬁled. Allowing Creditor’s Claims To share in the distribution of a debtor’s estate. • The debtor was insolvent on the transfer date or the debtor becomes insolvent because of the transfer. Fraudulent intent is present when: • The transfer makes it impossible for the creditors to receive full payment or to use legal remedies that would otherwise be available. Such property transfers may be seen as trying to undermine the bankruptcy laws and may be considered fraudulent under federal or state law. • A transfer is made in anticipation of debts to be incurred in the future which may be beyond the debtor's ability to repay as they mature. unconscionability or failure of consideration. • It is unmatured interest.. • A businessperson makes a transfer which leaves him with an unreasonably small amount of capital. • It is for breach of an employment contract.
claims against debtors who operate either a grain storage facility or a ﬁsh produce storage or processing facility—limited to $2. An individual may be denied discharge on any of the following grounds: • commission of a bankruptcy crime—Bankruptcy crimes typically relate to the proceedings and include such items as a false oath. severance and sick pay. (A discharge is usually granted.000 per farmer or ﬁsherman 6. delay or defraud creditors or the trustee. general unsecured creditors who ﬁle their claims on time 2. Any remaining property is distributed in the following order until exhausted: 1. If a debt is not discharged. the use or presentation of a false claim. gi�. salary and commission claims—for money earned within 90 days of the ﬁling of the petition or cessation of the debtor’s business.000 (multiplied by the number of employees minus the claims paid under priority 3) 5. contributions to employee beneﬁt plans—for services performed within 120 days before commencement of the case or cessation of the debtor’s business. whichever occurred ﬁrst —limited to $2. Discharge When all payments under the plan have been made and the bankruptcy estate is exhausted. postpetition interest on prepetition claims If any property remains. it is returned to the debtor. then the debt is ended and the debtor is relieved of the debt and the creditor simply doesn’t get paid. holders of penalty. forfeiture or punitive damage claims 4. estate. sale and excise taxes—must precede the petition date and cannot be older than three years Order of Distribution for Remaining Property In liquidation cases any available property is distributed ﬁrst among the priority claimants as discussed above. as well as regular earnings) 4. claims of consumer deposits—limited to $900 per consumer 7.Certiﬁed Bank Auditor Examination Review — Volume 7 3. or bribery in connection with the proceedings and withholding of records • fraudulent transfers—Fraudulent transfers must occur within a year preceding the case or a�er the start of the case and include acts such as destroying. If the claims within a particular class cannot be paid in full. If a debt is discharged.) However.000 per individual (includes vacation. wage. general unsecured creditors who tardily ﬁle their claims 3. the debtor may waive the discharge if he wants to remain responsible for the debts. they are paid on a pro rata basis. removing or concealing property with the intent to hinder. the debtor stays liable for the debt. certain taxes due the government 1) income taxes—for a taxable year that ended on or before the date of ﬁling the extension but cannot be older than three years 2) employment. the court may grant the debtor a discharge of any remaining debts. 102 . whichever came ﬁrst— limited to $2.
(5) Wheeler-Lea Act. (2) the Clayton Act. The Sherman Act (15 USC ˜ 1-7) was modiﬁed and appended by the Clayton Act (15 USC ˜ 12-17 ). • failure to explain—If a debtor fails to explain a loss or deﬁciency of assets. However. then discharge may be denied. the Sherman Act did not state exactly what types of action were prohibited. • refusal to testify or obey—If a debtor refuses to testify in the proceedings or to obey a court order. a�empt to monopolize. These federal statutes when combined with state legislation intend to promote and preserve competition in a free enterprise system and to prevent monopoly power. The act also made it illegal to monopolize. SECTION 2. either on their own or working together. if within one year and in connection with another bankruptcy case of an insider (insiders include relatives and partners of the debtor or directors and oﬃcers of a corporation). The scope of the federal antitrust statutes include: (1) the Sherman Antitrust Act. The wording of the act is broad and general and leaves much discretion to the federal courts for interpretation. • connection with another bankruptcy—The discharge may be denied for any of the above. • waiver of discharge—The discharge may be denied if the court approves a waiver of discharge. or conspire to monopolize any portion of interstate commerce or any portion of trade with foreign nations. then discharge may be denied. The coverage of these acts extends to interstate commerce among the several states. Overview Antitrust laws are designed to prevent monopoly and to maintain competition.Chapter Two — General Commercial Law • inadequate records—A debtor must maintain adequate records for determining his ﬁnancial condition.8: ANTITRUST Scope Businesses. (3) the Federal Trade Commission Act (FTC Act). unless failure to do so is justiﬁed. and (6) Celler Antimerger Act. The laws of antitrust and fair competition operate to make sure that the nation’s economic market isn’t harmed by such actions. • prior discharge—The discharge may be denied if there was a prior discharge within the past six years. The act declared that any combination. The FTC Act (15 USC ˜ 41. contract or conspiracy in restraint of trade made among the states or with foreign countries was illegal. (4) the Robinson-Patman Act. The Sherman Act The Sherman Act of 1890 is the primary tool of antitrust enforcement. but not intrastate activity. The sections added by the Clayton Act were then modiﬁed by the Robinson-Patman Act and the Celler-Kefauver Act. cannot defeat the competitive markets by banding together or by operating unfairly. All states have antitrust statutes applicable to intrastate activity. et seq) was modiﬁed by the 1938 Wheeler-Lea Act. 103 .
is declared to be illegal. Section 2: “Every person who shall monopolize. Two or more persons working together (i. group boyco�s and exchange of market information. Civil actions are more common than criminal proceedings and approximately 75% of these civil suits are se�led through consent decrees (a compromise between the government and the defendant). and customer restrictions. Examples of horizontal restraints include division of markets. and exclusive dealing contracts. combination in the form of trust or otherwise. A ﬁnal point: conduct that would violate the Sherman Act in the absence of union involvement is not immunized by the participation of the union..e. A horizontal restraint is an agreement among competitors such as manufacturers. retailers and wholesalers. First. would constitute a violation of Section 1. to monopolize any part of the trade or commerce among the several States. a combination) to ﬁx prices or divide markets in order to achieve anticompetitive results. shall be deemed guilty of a felony.Certiﬁed Bank Auditor Examination Review — Volume 7 To other points regarding the act should be mentioned here. Examples of vertical restraint include resale price maintenance. or with foreign nations.” These two sections complement each other in achieving the goal of preventing monopoly and anticompetitiveness. The Clayton Act The Clayton Act of 1914 was designed to strengthen and clarify the provisions of the Sherman Act. a manufacturer and a retailer in the same line of products). agricultural cooperatives. Violations of the Sherman Act Violations of both Sections 1 and 2 are felonies punishable for individuals by imprisonment of up to three years and ﬁnes up to $100.. A vertical restraint is an agreement between persons standing in a buyer-seller relationship (i. ﬁsherman’s organizations and export trade associations enjoy limited antitrust exemptions.” Section 1 is concerned with contract. location. or combine or conspire with any other person or persons. tying arrangements. territory. for example. Restraint of trade consists of horizontal and vertical types. For example. Corporations are punishable by ﬁnes up to $1 million. The Clayton Act makes price discrimination illegal unless it can be justiﬁed because of 104 . such as a contractor or manufacturer. It deﬁnes speciﬁcally what constitutes monopolistic or restrictive practices.000. to achieve a result forbidden by the antitrust laws. or a�empt to monopolize. the Sherman Act requires proof of actual and substantial anticompetitive eﬀect. or both. Second. where the property may be seized. labor unions. combination and conspiracies in restraint of trade. a union may not band together with a nonlabor party. price ﬁxing. whereas the Sherman Act does not. in restraint of trade or commerce among the several States. or conspiracy. The Sherman Act also contains the seldomused forfeiture remedy. or with foreign nations.e. Two substantial provisions in Sections 1 and 2 of the act are described below: Section 1: “Every contract.
Four Important Provisions of the Clayton Act Sections 2. Violations of the Clayton Act No criminal sanctions are imposed for violations of the Clayton Act. Mergers and the Clayton Act The scope of the Clayton Act in mergers includes both asset and stock acquisitions. • Section 8 prohibits a person serving on the board of directors of two competing companies (an interlocking directorate) if one or both companies are larger than a given size. 3. This section was modiﬁed by the Robinson-Patman Act in 1936. • Section 3 prohibits certain sales made on condition that the buyer not deal with the seller's competitors. the Clayton Act makes interlocking directorates (having the same individual on two or more board of directors) illegal if the corporations are competitive and if at least one of the corporations is of a certain minimum size. • Section 2 prohibits certain types of price discrimination. In addition. The Federal Trade Commission Act declared as unlawful “unfair 105 . the plaintiﬀ must ordinarily prove both the existence of an antitrust violation and damages resulting from that violation. • Section 7 prohibits certain corporate mergers and was modiﬁed by the Celler Act in 1950.Chapter Two — General Commercial Law diﬀerences in costs. private remedies as well as legal and equitable relief are available.” Exclusive or tying contracts are contracts in which the seller agrees to sell a product to a buyer on the condition that the buyer will not purchase products from the seller’s competitors. the Federal Trade Commission Act was designed to prevent abuses and to sustain competition. Legal relief is a private action for money damages. This means that the Clayton Act is more sensitive to anticompetitive practices than the Sherman Act. It also prohibits the use of exclusive or tying contracts when their use “substantially lessens competition or tends to create a monopoly. Rules of Mergers • horizontal merger—one between former competitors • vertical merger—a ﬁrm acquires a supplier or customer • vertically integrate backward or upstream—a business acquires a supplier • vertically integrate forward or downstream—a business acquires a customer • conglomerate merger—parties who were neither former competitors nor in the same supply chain The Federal Trade Commission Act Like the Clayton Act. The goal of the Clayton Act is to curb anticompetitive practices in their incipiency. However. In a private action. 7 and 8 are of particular importance. The act covers both mergers between actual competitors and vertical and conglomerate mergers having the requisite anticompetitive eﬀect. Under the Clayton Act. simply showing a probable—rather than actual—anticompetitive eﬀect can be enough cause for a violation of the act. The Clayton Act also made intercorporate stockholdings illegal if they tend to greatly reduce competition or to create a monopoly.
the FTC frequently enforces the Sherman Act indirectly and enjoins conduct beyond the reach of either the Sherman or Clayton Acts.Certiﬁed Bank Auditor Examination Review — Volume 7 methods of competition in commerce. Violations of the FTC Act No criminal sanctions or private damage remedies are imposed for violations of the FTC Act. However. The act also makes it unlawful for sellers to grant concessions to buyers unless concessions are granted to all buyers on terms that are proportionally equal. The FTC protects consumers who are injured by practices such as deceptive advertising or labeling. The act reaches the quantity discount. One of the goals of the FTC is to enforce antitrust laws and to protect consumers. 106 . As a result the Robinson-Patman Act is o�en called the chain store act. In addition. The FTC Act supplements the Sherman and Clayton Acts. a major form of price discrimination. Both the Department of Justice and the FTC can proceed against violators of the Robinson-Patman Act. The FTC Act authorizes the FTC to issue cease and desist orders prohibiting unfair methods of competition and unfair or deceptive acts or practices. agency/consignment arrangements.000 per day civil penalty is imposed for violating cease and desist orders. without regard to any eﬀect on competitors. It was wri�en to protect independent retailers and wholesalers from unfair discriminations by large chain stores and mass distributors which were supposedly obtaining large and unjustiﬁed price discounts because of their purchasing power and bargaining position.” The act also established the Federal Trade Commission (FTC) in 1914 and gave it the power and the resources to investigate unfair competitive practices. Most FTC investigations are se�led by a consent order procedure. a $10. Details of the Robinson-Patman Act The Robinson-Patman Act made it illegal: • to discriminate by granting unjustiﬁed quantity discounts which greatly reduce competition or tend to create a monopoly among sellers or buyers • to pay brokerage fees if no broker is involved in a transaction • to grant or obtain larger discounts than those available to competitors who purchase the same goods in the same amounts • for sellers to grant concessions to buyers unless concessions are created to all buyers on terms that are proportionally equal The Act applies only to sales. licenses or refusals to deal (selling to one ﬁrm while refusing to deal with another). The FTC has a dual role in prohibiting unfair methods of competition and anticompetitive practices. although not explicitly empowered to do so. The scope of Robinson-Patman Act applies to tangible personal property (commodities) and in the sale of services or intangibles such as advertising. These orders provide injunctive relief by preventing or restraining future unlawful conduct. not to leases. Robinson-Patman Act Congress passed the Robinson-Patman Act in 1936 to protect small competitors by amending the price discrimination section of the Clayton Act.
(3) or changing conditions. The burden of proving a defense is on the discriminating seller. The seller may avoid the consequences of the discrimination by proving one of three defenses: (1) cost justiﬁcation. the Wheeler-Lea Act was passed as an amendment to the FTC Act. Now the FTC has the authority to prohibit false and misleading advertising and product misrepresentation that harms consumers (as opposed to focusing just on harm to competitors). thus. It simply addressed the circumstances arising from the growth of chain stores. 107 . (2) meeting competition. it is designed to protect consumers rather than just competitors. • A mere showing that diﬀerent prices were charged is enough to establish a prima facie violation. • To violate the statute. the discrimination in price must be between diﬀerent purchasers.Chapter Two — General Commercial Law Violations of the Robinson-Patman Act The Robinson-Patman Act did not change any provisions for enforcement of the FTC Act. Wheeler-Lea Act In 1938. Celler Antimerger Act The Celler Antimerger Act of 1950 also amended the Clayton Act by making it illegal for a corporation to acquire the assets—as well as the stock—of a competing corporation if the eﬀect is to greatly reduce competition or to tend to create a monopoly. Proof of a prima facie case of price discrimination does not necessarily result in a liability. The Wheeler-Lea Act makes “unfair or deceptive acts or practices” in interstate commerce illegal.
income from property can be given to a party for a time. A charitable beneﬁciary can be changed if the will cannot fulﬁll its original charitable purpose. In community property states. 4. If someone dies without a will. spouses cannot be totally disinherited. A person can change his will by attaching a simple slip of paper with the desired changes. If someone dies with a will. property can be permanently given to a party. Once it is in effect. 5. In a trust. In a trust. 108 . 6. 9. If a trust is irrevocable. only proof or fraud or mistake will allow changing it. If two parties hold property as tenants in common. 1. the surviving party automatically gets title. an irrevocable trust cannot ever be terminated or changed. 14. 3. If a real estate property is owned by two joint tenants one can keep the other off the property. 12. Any sane person can make out a will. 11. state law does not ever change the will’s property distribution. In managing the property in a trust. state law determines who receives any property. 10. 8. 2. the trustee has the power to do whatever beneﬁts him 13. 7. A trust settlor can also be the trust’s beneﬁciary and trustee. then the title given later.Certiﬁed Bank Auditor Examination Review — Volume 7 Practice Challenge Questions True or False Questions: Circle T for True or F for False.
23. 22. otherwise Mr. Apt to be its agent must inform their past customers when Mr. Pat is the principal. Power of attorney allows an agent to do anything he wants with the principal’s property. An executory contract is one that hasn’t yet been performed completely. Peter is a building owner. 17. He hires a rental management ﬁrm to handle all rentals in the building for a fee. 28. Both the principal and the independent contractor are liable for the contractor’s negligence. A company which had authorized Mr. 29. 109 . Peter is the principal. 16. A salesman is liable if one of the watches he sells for the principal turns out to be stolen. Andrew is the agent. An agent cannot release any part of his responsibility to a subagent. Failing to complete even the tiniest step in a contract is automatically a breach. Paul is the principal. A promise to donate a large amount of money cannot be enforced. Performing a service for a person who accepts them is part of a quasi contract. Apt’s agency role is terminated. 21. 18. Paul turns his car over to Andrew to sell. 26. 27. Pat contracts Arthur to do whatever Arthur feels is necessary to bring his undeveloped land to a speciﬁc ﬂat ﬁnished grade. Phyllis wants to sell an expensive painting anonymously.Chapter Two — General Commercial Law 15. 25. She retains Angela to sell the painting. Apt could continue to bind the company. 19. 20. 24. Phyllis is the undisclosed principal and Angela is the agent. A principal can still be bound even if an agent exceeds the authority given by the principal. A contract cannot be enforced by anyone except one of the parties who made the contract. The rental management ﬁrm is the agent. Arthur is an independent contractor.
life insurance policy’s cash value is immune from attachment by the policy owner’s creditors.Certiﬁed Bank Auditor Examination Review — Volume 7 30. Once a life insurance policy is assigned. 110 . A ﬁre insurance policy holder cannot waive a lawsuit against the person who started the ﬁre. 38. 31. the new owner can usually change the named beneﬁciary. 33. 34. 40. A ﬁre insurance policy on property can only be taken out by the property’s actual owner. Once a life insurance policy is assigned. 44. claims for losses can be prorated among the policies. A six-month contract to perform services must be in writing in order to be enforced. If several property damage policies cover the same property. 41. 43. Liquidated damages is a contract clause which sets the monetary damages for breach. 37. 32. the new owner usually must make future premium payments. A life insurance policy pays regardless of the method or circumstances of the insured’s death—even suicide. A three-year contract to perform services must be in writing in order to be enforced. 39. A ﬁre insurance policy’s proceeds from a claim cannot be assigned. A patient can sue for breach of the contract made by her caregivers and her husband. Unwritten contracts are never enforceable. 42. A life insurance company has the right to ﬁle a lawsuit against the person who killed the insured. A life insurance policy with an irrevocable beneﬁciary usually requires approvals before its assignment. 35. 36.
only their real estate property b. 47. sign it oneself b. all their property. 1. nothing at all from the estate b. 46. More general partners means more people controlling and binding the partnership. all their property c. As tenants in the entirety. general partners have personal liability too. General partners have less personal risk that limited partners. Both general partners and limited partners have the same say in business operations. get it witnessed 111 . no more than his regular statutory amount c. the policy may be voided. plus property they share with other family members 3. Multiple Choice Questions Circle the le�er that best completes each sentence or answers each question. 48. More limited partners means more people controlling and binding the partnership. 53. give property to one’s spouse c.Chapter Two — General Commercial Law 45. If another partner commits a tort. Withdrawal of a limited partner is less disruptive than withdrawal of a general partner. A witness to a will usually can receive: a. 51. In making a will. payment just for signing the document 2. then the policy is canceled and the insurance is no longer in force. 50. If an insurance policy payment is late. and later dies from that illness. one must always: a. a husband and wife can hold: a. 49. 52. Adding a new limited partner is easier than adding a new general partner. If the insured person lies about an illness on the policy application.
proceeds cannot be collected upon the insured’s suicide d. a single missing or late payment results in policy cancellation 9. can be attached by the beneﬁciary’s creditors c. claims must be prorated among policies covering the same property b. follows the payments of debts and taxes c. The proceeds of a life insurance policy (with an irrevocable beneﬁciary): a. Which of these are not valid insurable interests for ﬁre or property damage: a. Insured = a mortgage debtor to the bank 7. happens before the probate court proceedings 5. Insured = home that A is contracted to buy b. Insured = one of the partners b. In settling an estate with a will. Policy Owner = D. Policy Owner = A. Insured = C’s neighbor’s house d. always comes ﬁrst b. within certain time limits. Policy Owner = a mother. can be attached by the insurance company’s creditors 8. a restricted. can be attached by the insured’s creditors d. Insured = the stars of ﬁlm in production d. Policy Owner = movie studio. Policy Owner = a partnership. a continuing. Which of these is not a typical clause in an insurance contract? a. Insured = building leased by B c. Policy Owner = B. Policy Owner = C.Certiﬁed Bank Auditor Examination Review — Volume 7 4. Which of these is not a valid insurable interests for life insurance: a. Policy Owner = a bank. can be attached by the policy owner’s creditors b. compensated guaranty c. Insured = D’s mortgaged property 6. Insured = her grown son c. A car loan with the borrower’s parent as cosigner is: a. a coinsurance policy requires the property owner to help pay for damage c. uncompensated guaranty b. distributing the property to heirs: a. not a guaranty 112 .
guarantor 12. The guarantor can then seek reimbursement from the principal. c. b. The guarantor can then seek reimbursement from the creditor. c. but only if the guarantor has defaulted ﬁrst b. 113 . The creditor must wait twice as long after default to collect from the guarantor. 15. the contract was void all along due to the creditor’s fraud 14. and the guarantor refuses to pay. A guarantor can defend himself against a creditor’s claims for payment if: a. The guarantor can then seek reimbursement from the creditor. a conditional guaranty c. The guarantor can’t be reimbursed. an absolute guaranty b. principal c. b. the principal went bankrupt c. Nothing changes in the guarantor/creditor/principal relationship. only the guarantor 13. The guarantor is not liable for any default unless he consented to the change. c. The guarantor can then seek reimbursement from the principal. If the principal had already performed when a guarantor satisﬁes the creditor’s claim: a. the contract was void all along due to the principal’s fraud b. If the principal and creditor change their contract to twice the work and money as before: a. the principal. both the principal and the guarantor c. the creditor may sue: a. creditor b. A person who promises to perform upon another person’s default is a: a. 16.Chapter Two — General Commercial Law 10. an uncompensated guaranty 11. b. If the principal has not yet performed when a guarantor satisﬁes the creditor’s claim: a. The guarantor can’t be reimbursed. If a principal defaults on payment. A guaranty agreement requiring that the creditor perform certain steps before holding the guarantor responsible is called: a.
review partnership books b. enroll a new general partner 19. for damage done during the agent’s frolic 114 . making any contracts with regular customers b. In a general partnership. an ongoing list of all current partnership assets c. c. The guarantor can be released from securing the principal’s performance. the agent’s fraud in carrying out the principal’s business c. all hiring and ﬁring of employees c. All existing liabilities are automatically extinguished. When a limited partnership is dissolved. d. the name of the partnership 22. sell partnership equipment d. In a general partnership. 18. determining routine business priorities 20. b. wound-up and terminated: a. The contract between the creditor and principal is void. All of these items are in the partnership agreements except: a. Both the principal and the agent are liable for a. capital contribution amounts from each partner d. c. 21. The principal is no longer liable for default.Certiﬁed Bank Auditor Examination Review — Volume 7 17. If a creditor lies about the principal to a guarantor securing the principal’s performance: a. any single partner acting alone has the right to: a. any salaries and proﬁt arrangement among partners b. b. approval of all other partners is required for: a. General partners are refunded their capital contributions before limited partners. Creditors are paid before partners. commit to a new ﬁeld of business c. the agent’s independent criminal acts d. Partners can still bind the partnership by making contracts with others. approving a partner’s personal use of partnership assets d. the principal’s defective merchandise b.
accident damages due to its drunken janitor’s late-night theft of the delivery van 25. except: a. contract another party to screen all new renters 26. price and schedule commitments made by its wholesale salesman b. the chief baker’s incorrect statements regarding contents of the baked goods d. commit to sell the property if the offer is very high b. a party’s failure to read the contract c. a bakery is not likely to be liable for: a. a person who had been assaulted agrees to refrain from suing the other party b. All of the following require a written contract. the lost business due to a restaurant’s inability to cook under a leaky roof c.Chapter Two — General Commercial Law 23. withhold information about building dangers from the building owners c. an agreement to assume the debt for another person’s home 27. a person agrees to pay three times the regular bank rate for a loan 115 . All of the following circumstances will typically support voiding a contract. except: a. accident damages due to its delivery van driver’s midday sleepiness c. his bartender’s onsite sale of liquor to minors b. a person agrees to rent the use of his address to an immigrant for INS papers c. injuries caused by his bouncer’s road rage en route to the bar 24. an agreement to purchase another person’s home c. Which is not compensatory damages for a breach of a restaurant’s rooﬁng contract? a. local vandalism done by the bar’s after-hours contract security service c. his janitor’s theft of liquor and subsequent after-hours drunk driving d. contract another party to do weekly lawn mowing d. a party’s fraudulent description of an item being exchanged 29. an agreement to paint another person’s home b. Under respondent superior. A bar owner can also be held liable for: a. Which one of the following is a legal purpose for a contract: a. a party’s duress caused by the other party’s overbearing threats b. a restaurant’s cost for repairs and cleaning of their building and furniture b. the cost to replace a very rare aquarium ﬁsh killed by unusually toxic rainwater 28. A rental apartment ﬁrm (responsible for renting and managing others’ buildings) can: a.
” c. except: a. once revoked by the offeror. One party promises to refrain from suing someone who has never wronged him. makes a the contract to provide beneﬁts for a third party 32. “I will pay $20 to whoever ﬁnds my dog. Which of the following is not available to a corporation ﬁling for bankruptcy: a. b. All of these are bilateral promises. cannot then be accepted by the offeree. his clothes b. his motorboat c.” b. Which of the following is true about offers: a. The offer. One party promises to exchange a very valuable item for a less valuable item. The offer is valid for months. Which of these is not a defective promise: a. 34. c. gets someone to purchase his right to payments due from the other contract party b. c. A person ﬁling for bankruptcy can expect to retain all of these items except: a. A person ﬁling for bankruptcy cannot expect to be relieved of: a. Chapter 7 b. One party promises to do something he is already bound to do. The offer is rejected if the offeree receives any other offers from anyone else. “I will mow your lawn if you will trim my trees. b. Chapter 11 c. 33.Certiﬁed Bank Auditor Examination Review — Volume 7 30. gets someone to take over his rights / responsibilities and the other party agrees c. his overdue cable bills c. his credit card debts b.” 31. his work equipment 36. Chapter 13 35. his child support obligations 116 . A novation is when one contract party: a. years—indeﬁnitely. “I will pay you $100 if you promise to send me your autographed baseball.
Chapter Two — General Commercial Law 37. Chapter 9 bankruptcy b. to eventually get all the amount due them b. examine the debtor’s recent transfers of property c. review all claims submitted by creditors 39. Once someone ﬁles Chapter 7 bankruptcy: a. All downtown retailers agree to stay open late for Midnight Madness sales. A large gas station franchise agrees with a similar franchise to keep prices high. Which is not likely to be a violation of the Sherman and/or Clayton Act? a. to be placed in a hierarchy with the other creditors c. 117 . Chapter 7 bankruptcy c. c. keeping poor records of his ﬁnancial condition in the past b. to see if the debtor has hidden property with a friend or family b. to see if the debtor is a mentally incompetent 40. he maintains control over which creditors get paid and when c. A trustee does all the following acts except: a. past poor decision making in managing his ﬁnancial affairs c. b. to see if the debtor has paid off one creditor in preference to the others c. Regarding repayment after a debtor’s bankruptcy. A debtor may be denied discharge on the following grounds except: a. Creditors can try to force a person into: a. to be paid at least some portion of the amount due to them 41. he loses much control over the resolution of his ﬁnancial problems 43. The trustee reviews the debtor’s past ﬁnancial dealings for all of the following reasons except: a. he is expected to provide a repayment plan and work with creditors to follow it b. A corporation requires that its suppliers not deal with any of its competitors. a fraudulent transfer of property 42. identify the reason the debtor was insolvent b. Creditors cannot usually expect: a. Chapter 13 bankruptcy 38.
mergers between competitors c. court orders 45. unjustiﬁed pricing discounts given to one buyer but not another b. Which act protects consumers who are injured by unfair competitive practices? a. The Robinson-Patman Act prohibits: a. ﬁnes b. the Sherman Act b.Certiﬁed Bank Auditor Examination Review — Volume 7 44. the Federal Trade Commission Act c. A violation of the Clayton Act could result in the following except: a. jail time c. the Clayton Act 46. competitors conspiring to hold prices high 118 .
The check is then provisionally credited by the bank. Answer: F—The beginning of the collection process is the deposit of a check in a customer’s account. the purchaser may actually take more than the seller. Answer: T 2.Answers to Practice Challenge Questions Practice Challenge Question Answers Chapter 1 Answers 1. Answer: T 9. This means that the seller may void the buyer’s title to the items he has received. Answer: F—Commercial paper consists of two basic types of instruments: drafts and notes. Answer: T 4. diligence. Answer: F—The provisions of the Code may be changed by agreement among the parties except as forbidden in the Code. however. Answer: F—In certain instances. If. 11. Answer: True 15. Answer: F—Perfection by attachment requires only the attachment of the security interest without any further action being required. Answer: F—An issuer must honor a draft or demand for payment which complies with the terms of the applicable letter of credit. 7. For example. Answer: T 12. Answer: T 8. 13. Answer: True 14. Good faith. Answer: T 10. 2) the delivery is in exchange for a bad check. 5. the buyer receives a voidable title. the buyer with voidable title sells to a good faith purchaser for value of the items. Answer True 6. reasonableness and care may not be disclaimed. This is often referred to as automatic perfection. 3. where: 1) the transferor is deceived as to the identity of the purchaser. or 4) the delivery was procured through fraud. the good faith purchaser receives full title and it ceases to be voidable by the original transferor. 3) it was agreed to be a cash sale. 119 .
and freedom from any security interest or lien of which the buyer has no knowledge. A negotiable instrument is a special type of written contract that represents credit and functions as a money substitute. Express warranties: Express warranties include any afﬁrmation of fact or promise which is not just sales talk or an opinion and which becomes part of the bargain. D 2. Commercial paper is a term used to describe certain types of negotiable instruments. An infringement may occur when the buyer furnishes speciﬁcations to the seller for the manufacturer of the goods. The buyer does not have to prove reliance on this afﬁrmation. 1. B 3. Implied warranties: Implied warranties arise as a matter of law and are legally present unless clearly disclaimed or negated. A 7. must be payable on demand or at a deﬁnite time 4. A negotiable instrument has the capacity to pass like money from person to person and is used as a medium of exchange. model or his description. A 11. B 8. Answer: T 17. A 5. and the buyer must protect the seller from any claims arising from such an infringement. B 6. Answer: T Multiple Choice Answers 1. must be in writing and signed by the drawer or maker 2. Liability for the breach of an implied warranty is based on the public policy of protecting the buyer of goods. A 4. B Essay Answers 1. Warranty of title: The seller warrants good title. There are two kinds of implied warranties. This warranty can only be disclaimed by speciﬁc language or circumstances which make it clear that the seller is not vouching for the title.Certiﬁed Bank Auditor Examination Review — Volume 7 16. 120 . 2. In this case the seller does not warrant against infringement. and the seller does not have to intend to create a warranty. must contain an unconditional promise or order to pay a sum certain in money 3. B 10. A seller who is a merchant warrants the goods to be free of any rightful claim of infringement. C 9. rightful transfer. D 12. must be payable to order or bearer 3. A seller warrants the goods to be of the same general quality of the sample.
Answers to Practice Challenge Questions
If the seller is a merchant who deals in goods of the kind involved in the contract, an implied warranty of merchantability is created. This warranty means that the goods are ﬁt for the ordinary purpose for which goods of this type are used and will pass without objection in the trade. This warranty applies to new and used goods in most states unless the warranty is modiﬁed or excluded. An implied warranty of ﬁtness for a particular purpose is created when the seller knows of the particular use of the good and knows the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods. The implied warranty of ﬁtness is applicable to both merchants and non-merchants. The warranty does not arise if the buyer’s knowledge is equal or superior to the seller’s. The good is warranted for the particular expressed purpose, and the seller may be liable if the good fails to so perform. 4. The express elements required for a sales contract are: 1. Parties: All parties involved or affected must be described. 2. Price: If a price is omitted, the contract will be enforced at a reasonable price. 3. Time for performance: If time is omitted, then reasonable time is implied. If the contract states that time is of the essence, then delay in performance is a material breach, which means the non-breaching party can terminate performance and sue for damages. 4.Subject matter: Typically, before an agreement is considered enforceable, the quantity must be included. If parties estimate the quantity involved, a quantity unreasonably disproportionate to the estimate will not be enforced. For the most part, if no mention of quantity is found, the contract is unenforceable. If, however, an estimate is not agreed on, a quantity in keeping with normal or other comparable prior output or requirements may be implied. 5. Protest is a formal method of fulﬁlling the conditions precedent. Protest is required only for drafts that are drawn or payable outside the U.S. The protest is a certiﬁcate which states that an instrument was presented for payment or acceptance and was dishonored. The protest explains why the instrument was not accepted or paid. 7. Holder in Due Course A third party who rightfully and legally possesses an instrument may be an assignee, a transferor, a holder or a holder in due course. If the instrument is a simple contract, the third party is an assignee. If the third party possesses a negotiable instrument that has been improperly negotiated, the party is a transferee with the status of an assignee. According to the UCC, a holder is a party in possession of a negotiable instrument issued, drawn or endorsed to his order, to him or bearer, or in blank. A holder in due course has a special status and a preferred position in the event there is a claim or a defense to the instrument. The distinct beneﬁt of negotiability is the ability to transfer the instrument to a holder in due course, that is a holder who takes free of personal defenses drawer/maker. There are three requirements that must be met before a holder becomes a holder in the due course. The holder must have acquired the instrument: 1. for value; 2. in good faith; 3. without notice that it is overdue, has been dishonored or any other person has a claim to or defense against it. 8. Depository bank: The ﬁrst bank to take an item even though it is also the payor bank, unless the item is presented for immediate payment over the counter.
Certiﬁed Bank Auditor Examination Review — Volume 7
9. An engagement by a bank or other person at the request of a customer that the issuer (bank or other person) will honor drafts or other demands for payment upon compliance with the conditions speciﬁed in the credit. A credit may either be revocable or irrevocable. 10. 1. a credit issued by a bank if it requires a documentary draft or documentary demand for payment 2. a credit issued by a person other than a bank if it requires that the draft or demand for payment be accompanied by a document of title 3. a credit issued by a bank or other person that conspicuously states that it is a letter of credit or is conspicuously so entitled There are two types of letters of credit: revocable and irrevocable. Once an irrevocable letter of credit is established with the customer, it can only be modiﬁed or revoked with the customer’s consent. Once it is established with the beneﬁciary, a letter of credit can be modiﬁed or revoked only with the beneﬁciary’s consent. Once a revocable letter of credit is established, it can be modiﬁed or revoked by the issuer without notice to, or consent by, the customer or the beneﬁciary. 11. 1. Each signature on a certiﬁcated security, in a necessary endorsement, on an initial transaction statement or on an instruction is admitted. 2. If the effectiveness of a signature is at issue, the burden of establishing effectiveness is on the party claiming under the signature. The signature is presumed to be genuine or authorized 3. If signatures on a certiﬁcated security are admitted or established, presentation of the security entitles the holder to recover on it, unless the defendant establishes a defense or a defect related to the validity of the security. 4. If signatures on an initial transaction statement are admitted or established, any facts presented in the statement are presumed to be true at the time it was issued. The issuer is free to show that later events changed the stated facts. 5. After it is shown that a defense or defect exists, the plaintiff must establish the fact that the defense or defect is ineffective against him 12. The seller may recover the price of: 1. certiﬁcated securities accepted by the buyer 2. uncertiﬁcated securities that have been transferred to the buyer or a person designated by the buyer 3. other securities, if efforts at their resale would be unduly burdensome or there is no readily available market for their resale 13. A secured transaction is a transaction in which a borrower or a buyer provides security that an obligation will be fulﬁlled in the form of personal property to a lender or a seller. 14. A secured party is a lender, seller or other person in whose favor there is a security interest. 15. 1. The debtor possesses rights in the collateral. 2. The debtor has authenticated a security agreement or the secured party has possession of the collateral. 3. There must be an obligation for value to be performed or given by the creditor.
Answers to Practice Challenge Questions
Matching Answers 1. 1. c; 2. a; 3. e; 4. b; 5. d 2. a. S; b. B; c. B; d. S; e. S; f. S; g. B; h. B 3. a. C; b. B; c. C; d. B
Chapter 2 Answers 1. True 2. False—Community property states allow the Widow’s Right of Election in which the surviving spouse gets a larger share of the property than the will reﬂected. 3. False—Joint tenants includes the right of survivorship—tenants in common does not. 4. True 5. False—Partial revocation must be a duly signed and attested instrument. 6. False—Children cannot make a will. 7. False—In joint tenancy, both parties have the right to be on the entire property. 8. False—Proof of fraud or mistake sometimes permits an irrevocable trust to be changed. 9. True 10. True 11. True—In a living trust, the settlor can also be the trustee and beneﬁciary. 12. False—The trustee cannot act for his own interests. 13. True 14. True 15. True 16. True 17. True 18. True 19. False—An agent can release simpler, nondiscretionary tasks to a subagent. 20. False—The agent (salesman) isn’t responsible for the bad acts of his principal. 21. False – Often, independent contractors work without the principal’s direction and therefore the principal isn’t liable for the independent contractor’s torts. 22. False—Most powers of attorney have a speciﬁed scope which the agent cannot overstep. 23. True—If the principal ratiﬁes the agent’s acts, then the principal is liable. 24. True 25. True 26. True 27. False—A constructive condition which is substantially performed does not amount to breach.
the policy is not required to pay. True 46. it’s always better to write any contract. True 53. novation and third-party beneﬁciaries allow suit on a contract. True—This is an example of the right of subrogation. unwritten contracts can be enforced. False—There is no legal right of subrogation in life insurance. False—If the insured dies by suicide within a certain time period. 30. 124 . 47. False—Promissory estoppel sometimes permits enforcement of a one-sided promise. True 33. 41. 40. 29. False—General partners have more control over the business than limited partners. True 44. False—Property can be insured by mortgagors or leaseholders. True 39. True 45. False—Usually limited partners have minimal control of the partnership. only accident and property insurance. 34.Certiﬁed Bank Auditor Examination Review — Volume 7 28. False—Except for those listed in the statute of frauds section. False—Assignment. True 50. False – One-year term is the cut off for the writing requirement under the statute of frauds. thus an additional limited partner doesn’t signiﬁcantly change the control structure of the partnership. True 31. but not the policy itself. 38. True 42. the policy’s cash value can often be part of the policy owner’s assets. True 35. False—General partners are personally liable for any partnership obligations which cannot be met by the partnership. However. 32. 49. 36. True 51. False—Some state laws and some policies allow a grace period for late payments to still be applied to the policy. False—The proceeds can be assigned. False—In bankruptcy. 37. True 52. 48. 43.
c 125 37.c 20. d 21.a 16. b 42. c 12. a 3. a 19. b 36. b 38.a 27. c 17. b 8. a . b 22. d 9. c 28. d 25. b 13. C 6.b 15. c 4. c 26.a 24. b 46. a 10. a 41. a 30. c 40.Answers to Practice Challenge Questions Answers to Multiple Choice Questions 1. c 44. b 11.a 39. b 45. c 43. b 31. c 14. b 2. c 33. b 34. b 7.b 32. b 5. c 35.b 18. b 23. b 29.
accident insurance—Provides coverage against expense. actions— In judicial proceedings: recoupment. suﬀer¬ing and loss of earnings resulting from personal injury or property damage.Glossary of Terms Certiﬁed Bank Auditor Glossary Section 7 • Chapters 1–2 absolute guaranty—An absolute guaranty agreement comes into eﬀect upon the default of the principal. suit in equity. Satisfaction means that the substituted performance is completed. she is an administratrix. and any other proceedings in which rights are determined. a creditor can initiate action against the guarantor at the same time it is initiated against the principal. In fact. 127 . set oﬀ. adequate assurance—A wri�en. administrator—An individual or a trust institution appointed by a court to se�le the estate of a person who has died without leaving a valid will. If the individual is a woman. a�er-acquired property—Property acquired by a debtor at a later time and which can become collateral. advising bank—Bank that gives notiﬁcation of the issuance of a credit by another bank. counterclaim. accommodation party—An individual who lends his name and credit to another party by signing an instrument. At that point the creditor may go directly to the guarantor to collect. accord and satisfaction—An acceptable substitute to the original promised performances An accord is an agreement whereby one party undertakes to perform (and the other to accept) something diﬀerent than what the original contract stated. convincing proof that a party will perform as promised.
bankruptcy—Legal process by which a debtor’s property and debts are resolved. receives value from the secured party. the�. escrow agent.e. credit union. and obtains rights in the collateral. 128 . advisory agent. and a�orney in fact. bankruptcy schedule—Lists the debtor’s secured and unsecured creditors. plus damage and personal injury caused to others. all of his property. or by conduct) who represents himself as a partner in an existing partnership. usage of trade. savings and loan association. a�achment—The creation of a security interest in property occurring when the debtor agrees to the security. bank—Any person engaged in the business of banking including a savings bank. a mortgage or security agreement). automobile insurance—Indemniﬁes against loss or damage to an automobile from collision. custodian.. and trust company. agency—A trustee may act for an individual in many capacities. A/R) to a lending institution. windstorm and ﬁre. such as depository agent. also called perfection by a�achment. or course of performance. aggrieved party—A party entitled to pursue a remedy. managing agent. assignor—A person giving the assets or transfers. assignee—A person receiving the assets or transfers. agent—The party who acts for the principal. agency coupled with an obligation—A source of reimbursement to the agent. agreement—The bargain of the parties in fact as found in their language or inferred from other circumstances. any property he claims is exempt and is a statement of the debtor’s aﬀairs. or when a party to a contract (assignor) transfers to a third party (assignee) his rights under the contract.g. apparent partner—A person (by words spoken or wri�en.Certiﬁed Bank Auditor Examination Review — Volume 7 agency coupled with an interest—This relationship exists when the agent has an actual beneﬁcial interest in the property that is the subject ma�er of the agency (i. apparent authority—Acts that seem to have or are represented to have authority and may therefore be legally binding. assignment— It involves transfer of assets (e. including course of dealing. anticipatory repudiation—A refusal to perform which occurs before performance is due and may be express or implied. automatic perfection—The a�achment of the security interest without any further action being required..
burden of establishing a fact—The task of convincing the triers of the fact that the existence of the fact is more probable than its nonexistence. buys in ordinary course from a person in the business of selling goods of that kind. general. rather than a speciﬁc piece of property. beneﬁciary— Person for whose beneﬁt a trust is created or the person to whom the amount of an insurance policy or annuity is payable. who in good faith and without knowledge that the sale to him is in violation of the ownership rights or security interest of a third party in the goods. buy sell agreements—A method whereby the surviving partner(s) can buyback (i. such as inventory.Glossary of Terms bargained-for consideration—Legally validates that there was some sort of exchange at the basis of the mutual assent. bill of lading—A document evidencing the receipt of goods for shipment issued by a person engaged in the business of transporting or forwarding goods. rather than a speciﬁc piece of property. or security payable to the bearer or the endorsed in blank. Devises and bequests are further subdivided into speciﬁc. buyer in ordinary course of business—A person. bequest—A gi� by will of personal property. or the remaining partner or partners can purchase the interest of the withdrawing partner. mutual promises. bilateral contract—A bilateral contract is a promise exchanged for another promise. such as inventory. blank endorsement—The endorser’s (customer’s) signa¬ture and converts order paper to bearer paper. purchase) the interest of the deceased partner. 129 .e. broker—An agent with spe¬cial. bearer paper—Negotiable instrument where payment will be made to anyone who pos¬sesses or bears the instrument. bearer—The person in possession of a negotiable instrument. blanket ﬁre insurance—Covers a class of property which may be changing. blanket ﬁre insurance policy—A ﬁre insurance policy which covers a class of property that may be changing. branch—Includes a separately incorporated foreign branch of a bank. and residuary. in other words. limited authority to obtain a customer for an owner who wants to sell or exchange property. document of title.
certiﬁcation—The usual method of accepting a check. or any other person that provides clearance of se�lement services with respect to ﬁnancial assets that would require it to register as a clearing agency under the federal securities laws but for an exclusion or exemption from the registration requirement. The borrower agrees that the lender will have the right to sell the collateral for the purpose of liquidating the debt if the borrower fails to repay the loan at maturity or otherwise defaults under the terms of the loan agreement. or typically recognized in the areas in which it is issued or dealt as a medium for investment. coguarantors—People who are jointly and severally liable to a creditor. claim—A debt or right to payment from the debtor that is held and asserted by the creditor. Source: coverageglossary. Whether negotiable or nonnegotiable. also called a security agreement. clearinghouse—An association of banks or other payors who regularly clear items.com certiﬁcated security—A share. it should have suﬃcient value to secure loan payment and be in a form that can be converted to cash.Certiﬁed Bank Auditor Examination Review — Volume 7 captive insurance company—An insurance company that has been set up to provide coverage at a lower cost than available by going through the general insurance market. A captive insurance company may be a nonadmi�ed. collateral—Pledged by a borrower to secure payment on a loan. Sometimes it may provide reinsurance to a self-insure or a domestic company. or an obligation of the issuer represented by an instrument issued in bearer or registered form of a type commonly traded on securities exchanges or markets. collecting bank—Any bank handling an item for collection except the payor bank. or speciﬁc property that a borrower pledges as security for the repayment of a loan. clearing corporation—A person that is registered as a clearing agency under the federal securities laws. participation. 130 . coinsurance clause—A clause that requires the owner/insured to bear a certain percentage of the loss when he fails to carry complete coverage. charitable trust—A trust that can beneﬁt an indeﬁnite group and can have perpetual existence. cha�el paper—Writing or writings that provide evidence of both an obligation to pay money and a security interest in or a lease of speciﬁc goods. a federal reserve bank. where the bank becomes the principal debtor because the bank appropriates from the depositor’s account the necessary funds to pay the instrument. commercial paper—Unsecured promissory note with a ﬁxed maturity. participation or other interest in the property of an enterprise of the issuer. The company’s stock is controlled by one interest or a group of related interests so as to provide coverage for their business operations. nonresident or foreign insurer. There are two types of collateral: tangible and intangible.. or by its terms divisible into a class or series of shares. interests or obligations.
consequential damages—Damages that arise from special circumstances surrounding a contract and are not normally foreseeable. conditional liability—The secondary liability of parties. 131 . displayed or presented in such a manner that a reasonable person against whom it is to operate ought to have noticed it.Glossary of Terms community property—Property held jointly by a husband and wife. 10th ed. 10th ed. family or household purposes. speciﬁcally : an act or forbearance or the promise thereof done or given by one party in return for the act or promise of another. also called special damages. constructive trust—A trust created by a court of equity for the purpose of preventing unjust enrichment as in the case where a transfer of property is obtained by fraud or violation of some ﬁduciary duty. conservator—The personal representative of a living but mentally incompetent person. consumer goods—Those goods bought primarily for personal. Source: Merriam-Webster. One party’s performance of a constructive condition triggers the other party’s duty to start performing his side of the bargain. conspicuous—A term or clause wri�en. bonding companies). continuing guaranty—A continuing guaranty agreement covers a contemplated series of ongoing transactions over a period of time. also called general damages. consideration—The inducement to a contract or other legal transaction. conglomerate merger—Parties who were neither former competitors nor in the same supply chain. family or household purposes. or that such a credit will be honored by the issuer or a third bank. conditional guaranty—A conditional guaranty agreement requires that the other acts (additional to the default of the principal) occur before the guarantor can be held liable.g.. contract—A commitment concerning the future conduct of the parties. compensatory damages—Damages designed to compensate the aggrieved party for his loss. Source: MerriamWebster. compensated guarantors—Guarantors who receive some pay or other consideration in direct exchange for his contract with the creditor (e. consumer—An individual who enters into a transaction primarily for personal. such as drawers and endorsers. conﬁrming bank—Bank that engages either that it will itself honor a credit already issued by another bank. constructive condition—Part of the detailed interaction between two parties who have contracted.
documents of title. cure—As a result of the rejection of goods: a right which allows the seller to correct the defective performance. devise—A gi� of real property by will of real estate. cha�el paper or securities. and any representative of credi¬tors. including an assignee for the beneﬁt of creditors. creditor—An entity to whom a debtor owes money. passbooks. and share dra�s (a Certiﬁcate of Deposit is not a deposit account). cross-claim or thirdparty claim. a receiver in equity. creditor beneﬁciary—A third party for whom a promisee has contracted for a promise to pay a debt. demand deposits. demand paper—A negotiable instrument that does not specify a due date. also called an obligee. creditor—A creditor includes a general creditor. creditor—The party entitled to receive payment or performance from the principal or obligor. An example of demand paper is a check. and an executor or administrator of an insolvent debtor’s or assignor’s estate. a lien creditor. unless the item is presented for immediate payment over the counter. cover—In revocation of goods: to purchase the needed goods from another source to substitute for those due from the seller. delivery—The voluntary transfer of possession of instruments. savings deposits. custodian bank—A bank or trust company that is supervised and examined by the state or federal authority having supervision over banks and is acting as custodian for a clearing corporation.Certiﬁed Bank Auditor Examination Review — Volume 7 course of dealing—A course of dealing in a previous transaction between parties which establishes a common basis of understanding for interpreting their expressions and other conduct. a trustee in bankruptcy. deposit accounts—Time deposits. defendant—A person in the position of defendant in a counterclaim. 132 . debtor—An entity who owes money or to which the bankruptcy case pertains. depository bank—The ﬁrst bank to take an item even though it is also the payor bank. credible witness—One who is competent to testify to support a will. customer—A buyer or other person who causes an issuer to issue a credit. a secured creditor.
etc. donee beneﬁciary—A third party for whom the promisee purchased the promise as a gi�. Dra� is also called a bill of exchange. endorsers—Legal signatory on the bank of an instrument. etc. a paper such as a document of title. also called a documentary demand for payment. in farming. also called a documentary dra�. security. estate— The property a person owns and protects. documentary dra�—An honor conditioned upon presentation of a document (i.e. dormant partner—A partner who is both silent and secret. 133 . due diligence—The care that a reasonable person exercises under the circumstances to avoid harm to other persons or their property.. invoice. in a profession. dock warrant. a paper such as a document of title. (also serves as a catchall for all other goods which defy classiﬁcation). 10th ed.e. economic expectancy—A veriﬁcation of a pecuniary link between the parties when insuring the life of a more remote family member. dock receipt. Source: Merriam-Webster. certiﬁcate. hold and dispose of the document and the goods it covers. the court can carry out the general charitable intention by prescribing the application of the trust property to another charitable purpose consistent with the original. who becomes a holder in due course. invoice. security. dra�—A signed wri�en order addressed by one person (the drawer) to another person (the drawee) directing the la�er to pay a speciﬁed sum of money to the order of a third person (the payee). including a bill of lading. or by a nonproﬁt organization or government agency.). warehouse receipt or order for the delivery of goods. endowment policy—A policy where the insured is required to pay premiums for a certain number of years. equipment—Those goods that are used or purchased primarily for use in a business. certiﬁcate. documentary demand for payment—An honor conditioned upon presentation of a document (i.Glossary of Terms disclosed principal—An agent for a disclosed principal reveals the principal’s identity. doctrine of cy pres (as nearly as)—A rule that provides that if a particular charitable purpose cannot be fulﬁlled in the manner directed by the se�lor.. dissolution—The legal destruction of the existing partnership relation. document of title—Any document which in the regular course of business or ﬁnancing is treated as adequately evidencing that the person in possession of it is entitled to receive. An endorsement is required on a negotiable instrument to transfer and pass title to another party.).
positive unequivocal refusal to perform. a breach of contract. also called a tying contract. also called guaranty insurance. milk. she is referred to as an executrix. The buyer does not have to prove reliance on this aﬃrmation and the seller does not have to intend to create a warranty. exemplary damages—Damages awarded to one party in order to punish the other’s conduct and to deter others from the same conduct in the future. 10th ed. wool. farm product—includes crops and livestock. ﬁdelity insurance—Insures against loss from dishonesty of employees or people in positions of trust. failure to perform—In contracts: doing a poor quality job. ﬁnancing statement—A document containing the addresses of both the debtor and the secured party.Certiﬁed Bank Auditor Examination Review — Volume 7 estoppel—A legal bar to alleging or denying a fact because of one’s own previous actions or words to the contrary. factor—An agent who has possession and control of another’s personal proper¬ty and is authorized to sell that property. breach. express contract—When the parties state their agreement orally or in writing. executed performance contract—A contract that has been fully performed by the contracting parties. wrongful act or omission. Most o�en awarded when the breach is fraudulent. express warranty—Any aﬃrma¬tion of fact or promise which is not just sales talk or an opinion and which becomes part of the bargain. express repudiation—A clear. 134 . If a woman is appointed. etc. executor—An individual or a trust institution nominated in a will and appointed by a court to se�le the estate of the testator is said to be the executor.) fault—A default. also called punitive damages. executory performance contract—A contract that has yet to be performed by the contracting parties. ﬁdelity bond—Provides coverage for losses resulting from the dishonest acts of people. The ﬁnancing statement also contains a description of the collateral. supplies used or produced in farming operations. exclusive contract—A contract in which the seller agrees to sell a product to a buyer on the condition that the buyer will not purchase products from the seller’s competitors. and the products of crops or livestock in their unmanufactured state (co�on. oppressive or malicious. Source: Merriam-Webster. express private trust—A ﬁduciary relationship with respect to property.
general intangible—goodwill. general damages—Damages designed to compensate the aggrieved party for his loss. frolics—When a servant neglects his master’s business and pursues his personal interests. general partner—A partner who is liable for all partnership liabilities plus any unpaid contributions. grace period—A period of time a�er payment is due within which payment can be made without the policy lapsing. and standing timber to be cut. good faith—Honesty in fact and the observance of reasonable commercial standards of fair dealing. physical nature. holder in due course—The person who obtains title to a transferred negotiable instrument. patents and copyrights. also called compensatory damages. friendly ﬁre—Damage caused by smoke from a ﬁre in a ﬁreplace. They also include the unborn young of animals. general agent—An agent who is authorized to conduct a series of transactions in the continuous service of the principal. speciﬁc creditor. general legacy—A legacy that can be satisﬁed by the delivery of any property of the general type. general power of a�orney—A power of a�orney which gives the agent the authority to act in most respects for the principal and has a broad scope of authority. goods—All items which are moveable and personal property of a tangible. Source: Merriam-Webster. genuine—Free of forgery or counterfeiting. growing crops. 135 . fungible—Being of such a nature that one part or quantity may be replaced by another equal part or quantity in the satisfaction of an obligation. water or chemicals. guarantor—any party that promises the creditor to be liable in case of the principal’s failure to pay or perform. good faith purchaser—One who buys the collateral and is unaware of the existence of any security interest in the property. guardian—The personal representative of a living person who is a ward (generally a child).Glossary of Terms ﬁre insurance—Covers direct ﬁre damage plus any indirect ﬁre damage such as damage from smoke. general guarantor—A guarantor who is not limited to a single. also called a surety. 10th ed.
hostile ﬁres—Unintentional ﬁres or ﬁres that have le� the intended burning spot. implied warranty of merchantability—Warranty that the goods being sold are ﬁt for the ordinary purpose for which goods of this type are used and will pass without objection in the trade. retailers and wholesalers. The implied warranty of ﬁtness is applicable to both merchants and nonmerchants. 136 . illusory promise—A statement that purports to be a promise but is not because the promisor need not perform it. implied warranty of ﬁtness—A warranty created when the seller knows of the particular use of the good and knows the buyer is relying on the seller’s skill or judgment to select or furnish suitable goods. implied in fact contract—When the agreement is manifested only by the two parties’ conduct. but A refuses to honor the unspoken agreement. but not in any writing. see also quasi contract. Liability for the breach of an implied warranty is based on the public policy of protecting the buyer of goods. implied warranties—A warranty that arises as a ma�er of law and is legally present unless clearly disclaimed or negated. when A’s conduct (mis)leads B to think they have a certain ﬁrm agreement and B relies upon that agreement B then gives some beneﬁt to A. Identiﬁed (identiﬁcation)—In the UCC: designated as the speciﬁc goods that will be utilized in the transaction. impaired claim—A debt that the bankruptcy proceedings either decrease or delay. a policy cannot be contested because of concealment or misstatements.Certiﬁed Bank Auditor Examination Review — Volume 7 holder—Person in possession of a negotiable instrument that is payable either to the bearer or to an identiﬁed person that is the person in possession. not a failure or refusal to perform. horizontal restraint—An agreement among competitors such as manufacturers. implied repudiation—When the promisor makes it impossible for himself to perform. independent contractor—A person whose services are contract¬ed for by another person. implied in law contract—This is similar to an implied-in-fact contract For example. inability to perform—An excuse from liability for a contract breach. typically two years. incontestability clause—A clause where a�er a certain period of time. This warranty applies to new and used goods in most states unless the warranty is modiﬁed or excluded. where the defending party answers that the reason for the breach was because of an inability to perform. horizontal merger—A merger between former competitors.
also called a living trust. Source: Merriam-Webster. including raw materials. inter vivos—A trust created by a transfer of property during one’s lifetime. or who cannot pay his debts as they become due. works in process. joint and several liability—Where two people are responsible for an action and can share liability for the injury. insolvency proceedings—Any assignment for the beneﬁt of creditors or other proceedings intended to liquidate or rehabilitate the estate of the individuals involved. instruments—Negotiable instruments. intermediary bank—Any bank to which an item is transferred in the course of collection except the depository or payor bank. insolvent—A person who either has generally ceased to pay his debts in the ordinary course of business other than as a result of a bona ﬁde dispute. irrevoca¬ble le�er of credit—A le�er of credit which can only be modiﬁed or revoked with the customer’s or beneﬁciary’s consent. interlocking directorates—Having the same individual on two or more board of directors. the insured and the event. whether or not earned by performance). and any other writing that evidences a right to the payment of money and is not itself a lease or security agreement. issuer—A bank or other person issuing a credit. checks. and materials used or consumed in a business involuntary bankruptcy—A bankruptcy that is started when one or more of a debtor’s creditors ﬁles a petition. partners. may be negotiable dra�s. insurance—Coverage by contract whereby one party undertakes to indemnify or guarantee another against loss by a speciﬁed contingency or peril. insider—A debtor’s relatives. intestate— Without having made and le� a valid will.Glossary of Terms infringement—An act or claim that interferes with an exclusive right of an owner. or (if debtor is a corporation) directors or executives. 137 . certiﬁcates of deposit and promissory notes. intangible collateral—Collateral that is an account (any right to payment for goods sold or leased or for services rendered. inventory—Goods that a person holds for sale or lease and that are to be furnished under a contract of service. 10th ed. or who is insolvent within the meaning of the federal bankruptcy law. ﬁnished goods. insurable interest—The relationship between the policy owner. intentional torts—A tort prompted by a feeling of ill will. or any general intangible. securities such as stocks and bonds.
locus poenitentiae—A person who repents before performing any illegal part of the contract. maker—Regarding negotiable instruments: the primary party. limited partner—A partner who is obligated to the partnership to make any contribution stated in the certiﬁcate. also called inter vivos. legal theory of estoppel—If a person by words spoken or wri�en or by conduct represents himself as a partner in an existing partnership. all partners are considered members. liquidated damages—The money damages applicable in the case of a breach. liability—Probable future sacriﬁce of economic beneﬁts arising from the present obligations of a particular entity to transfer assets or provide services to other entities on the future as a result of past transactions or events. that person is not a partner but is liable to any party to whom such representation has been made. an exporter) to draw a dra� to a stated amount of money against the accepting bank.Certiﬁed Bank Auditor Examination Review — Volume 7 joint tenancy—Holding of property by two or more persons in such a manner that. the survivor(s) take(s) the entire property. legal relief—A private action for money damages. le�er of credit—A formal document in le�er form addressed to and authorizing the beneﬁciary (for example. also called place for repentance. 138 . life insurance—insurance providing for payment of a stipulated sum to a designated beneﬁciary upon death of the insured. legal detriment—A promise to perform an act that one had no prior legal obligation to perform It can also be to refrain from doing something that one could legally do and had no prior legal obligation not to do. limited payment life insurance—Requires the payment of premiums over a ﬁxed number of years and the policyholder is insured for life. Limited Liability Companies (LLC)—A partnership where there is no distinction between general or limited partners. 10th ed. liability insurance—Protects the insured against liability for accidental damage to people or property and typically includes the duty to defend the insured in a lawsuit brought by third parties. upon the death of one joint owner. living trust—A trust created by a transfer of property during one’s lifetime. Source: Merriam-Webster. Limited Liability Partnerships (LLP)—A partnership where there are both general partners and limited partners.
compensatory damages. and cashier’s checks.Glossary of Terms malpractice insurance—A form of personal liability insurance used by doctors. note—A type of negotiable interest which is a wri�en promise to pay (other than a certiﬁcate of deposit) by a party—the maker—a sum certain in money to the order of another party—the payee or the bearer of the note. The parties may also mutually agree to cancel their relationship. master—In tort liability: one who employs another person. punitive damages or liquidated damages. he must be named or otherwise indicated therein with reasonable certainty. mutuality of obligation—Each party is bounded or neither party is bound. This includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more countries. bank certiﬁcates of deposit. nontrading partnership—Engages in the production of merchan¬dise from raw materials or sells services. merchant—A person who deals in the goods being sold or who holds himself out as having knowledge or skill peculiar to the goods involved in the transaction. 139 . notice of breach—Notice of any alleged breach of express and implied warranties. money—A medium of exchange currently authorized or adopted by a domestic or foreign government. lawyers and other professionals. negotiable instruments—(1) It must be in writing and signed by the maker or drawer. money damages—Nominal damages. Protects against liability for harm caused by errors or negligence in performing work. (3) it must be payable on demand. consequential damages. Hence this form of commercial paper includes promissory notes. notice of dishonor—Notice that a negotiable instrument has not been honored by the bank. midnight dead¬line—The time by which a bank must provide notice of dishonor: before midnight of the next banking day following the day the bank received the item. and (5) when the instrument is addressed to the drawee. mutual agreement—In contracts: the parties may agree in their contract to terminate the relationship at a deﬁnite point in time or on completion of a task. (2) it must contain an unconditional promise or order to pay a certain sum in money. (4) it must be payable to order or to bearer. marshalling of assets—A rule which comes into play when a ﬁrm is insolvent and a court of equity becomes responsible for distribution of the partnership’s assets. nominal damages—Symbolize the wrong done by the mere breach of con¬tract and are typically one dollar.
the one who makes the oﬀer). partnership—An association of two or more people to carry on as co owners of a business for proﬁt. oﬀeror—The party to a contract who initiates the ﬁnal exchange of promises. organization—In the code. partnership at will—When a deﬁnite term of duration of a partnership is not speciﬁed in the agreement. also called a promisee.. option contract—An contract oﬀer that cannot be revoked for a certain time period so that the oﬀeree can decide whether or not to accept it. an organization is deﬁned as a person other than an individual. oﬀeree—The party to a contract who responds to the ﬁnal exchange of promises. Parol Evidence Rule—Prohibits the introduction of subsequent evidence that would alter a wri�en contract. (i.Certiﬁed Bank Auditor Examination Review — Volume 7 novation—An agreement whereby a new party is substituted for an original party to a contract. overdra�—The amount by which the sum of checks paid against an account exceeds the balance in the account. also called a promisor. A ﬁxed sum is then paid to the beneﬁciary on the insured’s death.e. obligor—The party who borrows money or assumes direct responsibility to perform a contractual obligation. order of relief—Court order from the bankruptcy judge (when he decides that the debtor is entitled to bankruptcy law protection) authorizing the bankruptcy. also called whole life insurance. order paper—A negotiable instrument which states that payment will be made to the order of a designated payee or to anyone that such a payee may order or direct. the trustee’s actions. partially disclosed principal—The third party knows that a principal exists but does not know the principal’s identity. partial integration rule—The parties intend the writing to be ﬁnal on the terms as wri�en but not necessarily complete on all terms of the agreement. ordinary life insurance—Insurance that requires the insured to pay premiums over his life. Order paper can be negotiated only by both endorsement and delivery.e. option—Agreement that permits one to buy or sell something within a stipulated time according to the terms of the agreement. the selling of assets and the payment of creditors. 140 . the one who receives the oﬀer and accepts or rejects it).. also called principal or principal debtor. (i.
payee—One to whom money is or is to be paid. if an interest rate is not so speciﬁed. payor bank—The drawee of a dra�. speciﬁcally : the notice taken or statement made by a grand jury of an oﬀense from their own knowledge without a bill of indictment laid before them. perfection—Pu�ing the world on notice that a secured party has a security interest in a property. or the act of oﬀering at the proper time and place a document (as a bill of exchange) that calls for acceptance or payment by another. agency or instrumentality. presenting bank—Any bank presenting an item to a payor bank. pledge (or pledge transaction)—The simplest type of secured transaction where a borrower gives the physical possession of his property (i. performance—What the promisee/oﬀeree and promisor/oﬀeror agree to do for one another. also called automatic perfection. or any legal or commercial entity. estate. power of a�orney—A formal document for conferring authority on an agent. present value—The amount as of a date certain of one or more sums payable in the future.e. performance bonds—Bonds that provide coverage against losses resulting from the failure of a contracting party to perform the contract as agreed. perfection by a�achment—A type pf perfection which requires only the a�achment of the security interest without any further action being required. signed by the principal in the presence of a notary public. partnership. joint venture. 141 . public corporation. corporation.Glossary of Terms party—In the UCC: a person or business that has engaged in a transaction or made an agreement. Source: Merriam-Webster. business trust. diamond ring) to a lender as security for a loan. Typically. Source: Merriam-Webster. 10th ed. discounted to the date certain by use of either an interest rate speciﬁed by the parties if that rate is not manifestly unreasonable at the time the transaction is entered into or. 10th ed. limited liability company. a commercially reasonable rate that takes into account the facts and circumstances at the time the transaction was entered into. person—In the UCC: an individual. presentment—The act of presenting to an authority a formal statement of a ma�er to be dealt with. trust. association. government. governmental subdivision. personal defense—An ordinary defense in a contract action—such as failure of consideration or nonperformance of a condition—which argues that the maker or drawer of a negotiable instrument is precluded from raising against a person who has the rights of a holder in due course. the lender can sell the property to satisfy the obligation or debt. If the loan is not repaid..
when A’s conduct (mis)leads B to think they have a certain ﬁrm agreement and B relies upon that agreement B then gives some beneﬁt to A. promisee—The party to a contract who responds to the ﬁnal exchange of promises. implies ratiﬁcation. the one who makes the oﬀer). 142 . (i. The principal’s conduct. lien. The protest is a certiﬁcate which states that an instrument was presented for payment or acceptance and was dishonored. oppressive or malicious. also called principal. protest—A formal method of fulﬁlling the conditions precedent. Punitive damages are most o�en awarded when the breach is fraudulent. and explains why the instrument was not accepted or paid. the one who receives the oﬀer and accepts or rejects it).. see also implied in law contract. also called a oﬀeror.Certiﬁed Bank Auditor Examination Review — Volume 7 primary parties—Makers of notes and the acceptors of dra�s and are the parties who will actually pay the instruments. negotiation. discount. also called an oﬀeree. principal debtor—The party who borrows money or assumes direct responsibility to perform a contractual obligation. They are also awarded to deter others from the same conduct in the future. security interest. or obligor. qualiﬁed endorsement—The transferor disclaims any liability on the instrument.e. or any other voluntary transaction which creates an interest in property. principal—The party who borrows money or assumes direct responsibility to perform a contractual obligation. the party who controls the agent and for whom the agent acts. (i. purchaser—A person that takes by purchase. also called exemplary damages. inconsistent with the intent to reject the contract. or obligor. promisor—The party to a contract who initiates the ﬁnal exchange of promises. quasi contract—This is similar to an implied-in-fact contract.S. For example. issue or re issue. punitive damages—Punitive damages are awarded to one party in order to punish the other’s conduct. Or.. purchase—To take by sale. lease.e. gi�. pledge. also called principal debtor. ratiﬁcation—The principal—with knowledge of all material ma�ers—has expressed or implied adoption or conﬁrmation of a contract entered into on his behalf by a person with no authority to do so. Protest is required only for dra�s that are drawn or payable outside the U. promissory estoppel—The legal means used to enforce such promises almost as though they were contracts. mortgage. but A refuses to honor the unspoken agreement.
restitution—When the court requires a party who has been unjustly enriched to return an unfairly-gained item or its value. If no time is agreed upon. and a trustee. restricted guaranty—A restricted guaranty agreement is for a speciﬁed single transaction or speciﬁed group of transactions. refusal to deal—Selling to one ﬁrm while refusing to deal with another. forgery of a necessary signature. representative—A person empowered to act for another including an agent. etc. so the maker or drawer of a negotiable instrument can raise it even against a holder in due course. or if the security so states. residuary gi�—A gi� that includes all the personal property not included in the speciﬁc or general bequests or devises. registered form—Re: certiﬁcated securities: Speciﬁes a person entitled to the security or the rights it represents. replevin—The recovery by a person of goods or cha�els claimed to be wrongfully taken or detained upon the person’s giving security to try the ma�er in court and return the goods if defeated in the action. purpose and circumstances of an action. reasonable time—Any time which is not manifestly unreasonable may be ﬁxed by agreement. Examples are: fraud in fact. rescission—When the court disaﬃrms the contract and restores the parties to the position they occupied before making the contract. remedy—Any remedial right to which an aggrieved party is entitled with or without resort to a tribunal. 143 . or the writ or the common-law action whereby goods and cha�els are replieved. 10th ed. it is within a reasonable time. Source: Merriam-Webster. executor or administrator of an estate. A restrictive endorse¬ment is o�en used when a check is deposited in a bank for collection. record—Information that is inscribed on a tangible medium or that is stored in an electronic or other medium and is retrievable in perceivable form. respondent superior—A concept which states that a master is liable to third persons for torts commi�ed by his servants within the scope of their employment and in pursuance of the master’s business. an oﬃcer of a corporation or association. restrictive endorsement—Restricts the endorsee’s use of the instrument and does not prevent further transfer or negotiation of the instrument. refusal to perform—A type of breach of contract. its transfer is registered on books maintained for that purpose by or on behalf of the issuer.Glossary of Terms real defense—A type of defense that is good against any possible claimant. A reasonable time depends on the nature.
sale on approval—In a consumer purchase: a transaction where the goods are delivered for use. negotiable instruments).. servant— In tort liability: a person who is employed with or without pay to perform personal services for a master and is subject to the master’s right or power of control. not true insurance. but his interest is not known to third parties. sight dra�—A dra� that is payable on presentation to the drawee. security agreement—Writing or writings that provide evidence of both an obligation to pay money and a security interest in or a lease of speciﬁc goods. sale on return—When goods are delivered for resale. secured party—A lender. record or notice which is deposited in the mail or delivered for transmission by any of the usual means of communication and with postage or cost of transmission provided. security interest—An interest in personal property or ﬁxtures which secures the payment or the performance of an obliga¬tion. the customer or the beneﬁciary. right—The same as a remedy. semi intangible collateral—Collateral that has physical existence but is simply representative of a contractual obligation (i. secret partner—A partner who may advise management and participate in decisions. sale—In a sales transaction: title to goods exchanged for a price. seller or other person in whose favor there is a security inter¬est. 144 . also called a trustor.e. se�lor—An individual who makes a trust.Certiﬁed Bank Auditor Examination Review — Volume 7 resulting trust—A trust created by a court of equity when a party with legal title to property is not intended to have it. secondary parties—Drawers of dra�s and checks and endorsers of any instrument. secured debt—A debt which is accompanied by giving the creditor an interest in property. send—A properly addressed writing. secured transaction—A transaction in which a borrower or a buyer provides security in the form of personal property to a lender or a seller that an obligation will be fulﬁlled. scienter—Intention to mislead. self-insurance—The advance ﬁnancial preparation for possible losses and not a distribution of risk. also called cha�el paper. revocable le�er of credit—A le�er of credit that can be modiﬁed or revoked by the issuer without notice to. or consent by.
A�er the time period expires. subagent—A third party who has been delegated the duties of an agent by that agent. Subrogation—The right of an insurance company to assume an injured party’s legal claims against third parties. speciﬁc performance—When the court requires the breaching party to do exactly what he agreed to do under the contract. or any territory or insular possession subject to the jurisdiction of the United States. speciﬁc legacy—A gi� of particular property so identiﬁed as to distinguish it from other property. stale check—A check that is over six months old. special agent—An agent who is not in the continuous service of the principal. 145 . also called a speciﬁc legacy. if the seller becomes insolvent within ten days of the buyer’s ﬁrst payment. also called a speciﬁc devise. special guarantor—A guarantor who limits his promise to a single transaction and/or a speciﬁc creditor. suicide clause—A clause in an insurance policy that states the policy will not cover the insured’s suicide for a certain period of time. Puerto Rico. also called consequential damages. special property interest—An interest where the buyer has (1) an insurable interest in the goods. (3) the right to sue for damages caused by any third party who wrongfully destroys or damages the goods. the District of Columbia. silent partner—A partner who does not participate in management. special damages—Damages that arise from special circumstances surrounding a contract and are not normally foreseeable.Glossary of Terms signed—Any symbol executed or adopted by a party with present intention to authenticate a writing. Further negotiation requires the endorsee’s signature. suicide is covered. state—A state means a state of the United States. (2) the right to inspect the goods at a reasonable time and at the buyer’s expense. speciﬁc devise—A gi� of particular property so identiﬁed as to distinguish it from other property. the United States Virgin Islands. subguarantors—A guarantor’s guarantor. special endorsement—An endorsement that speciﬁes the party (endorsee) to whom or to whose order the endorsement makes the instrument payable. Typically this time period coincides with the one used in the incontestability clause. and (4) the right to demand the goods upon oﬀering the full contract price. subsequent purchaser—A person who takes other than by original issue. A special guarantor’s promise can¬not be assigned to a new creditor.
termination at will—When the agency agreement does not state a deﬁnite time period. except in concert with the other. a legally just cause of exclusive possession. tangible collateral—Physical property or goods. she is a testatrix.Certiﬁed Bank Auditor Examination Review — Volume 7 surety—A surety is a guarantor or other secondary obligor. testamentary trust—A trust established by the terms of the will. suretyship—The relationship where one person agrees to be answerable for the debt or default of another person. Source: Merriam-Webster. tort—A wrongful act other than a breach of contract for which relief may be obtained in the form of damages or an injunction. upon his death. If the insured dies within that term. If the individual is a woman. passes as such to his heirs or devisees and not to the survivor(s). testator—Person who has made and le� a valid will at his death. tender—In contract law: the presentation of performance. Source: Merriam-Webster. tenancy in common—Holding of property by two or more people in such a manner that each has an undivided interest which. Source: Merriam-Webster. then the life insurance policy pays. termination—The winding up process is completed. either the principal or the agent may terminate the relationship. 10th ed. something that justiﬁes or substantiates a claim. tenancy by the entirety—Tenancy by a husband and wife in such a manner that. transferor—One that conveys a title. 10th ed. or property. 146 . trading partnership—Engages in the business of buying and reselling merchandise. 10th ed. right. third party beneﬁciary—When one party contracts with a second party for the purpose of conferring a beneﬁt upon a third party. neither husband nor wife has a disposable interest in the property during the lifetime of the other. title—All the elements constituting legal ownership. the instrument (as a deed) that is evidence of a right. term life insurance—Covers the insured for a ﬁxed number of years. term—The portion of an agreement which relates to a particular ma�er.
a person responsible for managing the debtor’s assets. undisclosed principal—The principal’s existence is a secret from the third party. or an obligation of the issuer which is not represented by an instrument and whose transfer is registered on books maintained for that purpose by or on behalf of the issuer. unimpaired claim—A debt that is essentially unchanged by the bankruptcy proceedings. An agreement by which an individual or a corporation as trustee holds title to property for the beneﬁt of one or more persons.e. in bankruptcy law. unity of title—The joint tenants must have the same estate created in the same manner. This includes a forged signature.. or apparent authori¬ty. uncompensated guarantors—A guarantor who doesn’t receive pay or anything else in direct exchange for his contract with the creditor. (i. trustor—An individual who makes a trust.Glossary of Terms trust— Fiduciary relationship in which one person (the trustee) is the holder of the legal title to property (the trust property) subject to an equitable obligation (an obligation enforceable in a court of equity) to keep or use the property for the beneﬁt of another person (the beneﬁciary). unilateral contract—A promise exchanged for an act of performance. the oﬀeror promises the oﬀeree a beneﬁt if the oﬀeree performs some act). either one of a class or series. unity of time—The joint tenants’ ownership must be created at the same time.. implied. trustee— Individual or a trust institution that holds the legal title to property for the beneﬁt of someone else. a cosigner on a loan). participation or other interest in property. unauthorized signature—A signature made without actual. 147 . an enterprise of the issuer. of a type commonly traded on securities exchanges or markets. uncertiﬁcated security—A share. tying contract—A contracts in which the seller agrees to sell a product to a buyer on the condition that the buyer will not purchase products from the seller’s competitors. usually under the terms of a will and other wri�en agreement. (e. participation. unilateral action—Either party to an agency agreement acting independently to terminating an agency even though he has no right. Or. or by its terms divisible into a class or series of shares. also called an exclusive contract.g. unity of interest—Each owner having equal shares of the property. also called a se�lor. interests or obligations. unity of possession—Each owner having the right to possess all of the real estate subject to the owner’s rights of possession.
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