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REGULATION 5

Contracts and Sales


1. Contracts 3
2. 5ales 31
3. Employer-employee law 47
4. Class questions 57
BL\Sl\\eSS t . ~ w 17 - 21%'
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Regulation 5
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I. INTRODUCTION
A. Terminology
Broadly speaking, a(contracOs a promise that the law will enforce.
PASS KEY
Regulation 5
CONTRACTS
While the examiners rarely ask you to describe a contract using the descriptive terms below, it is important
for you to understand them, because the examiners sometimes use them in their questions.
ANCILLARY MATERIAL (for Independent Review)
1. Method of Formation
a. Express Contract
A contract formed by language, oral or written, is an express contract.
EXAMPLE
If Ann promises to give Barb $10 if Barb will wash Ann's car, the contract is express.
b. Implied-in-Fact Contract
A contract formed by conduct is an implied-in-fact contract.
EXAMPLE
Alex goes to Doctor and tells Doctor that he is sick. Doctor examines Alex and gives him an
antibiotic. Alex and Doctor have entered into a contract for Doctor's services even though no
oral or written promises were exchanged. Their conduct implies their intent to enter into a
contract.
c. Implied-in-Law Contract or Quasi-Contract
A quasi-contract is not a contract at all. It is a remedy that allows a plaintiff to
recover a benefit unjustly conferred upon the defendant, a remedy to prevent
unjust enrichment.
EXAMPLE
Joanne gives Keith $10,000 as a down payment to purchase Keith's house. The contract is
oral and as will be discussed later, is unenforceable. Keith decides to back out. Joanne can
recover the down payment in quasi-contract.
END OF ANCILLARY MATERIAL
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2.
Regulation 5
,: B.
Whel\i- lel\\N
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One Promise or Two - Unilateral and Bilateral Contracts
a. Unilateral Contract
In a unilateral contract, there is one promise, which is given in exchange for
performance (e.g., Ann promises to give Barb $10 if Barb will wash Ann's car). A
contract is not formed until performance is completed.
b. Bilateral Contract
In a bilateral contract, there are two promises-a promise is exchanged for a
promise (e.g., Ann promises to give Barb $10 if Barb promises to wash Ann's
car). Here, a contract is formed as soon as the promises are exchanged.
3. Stage of Performance
a. Executory Contract
A contract is executory if duties remain to be performed under the contract. A
contract may be wholly executory (neither party has performed) or partially
executory (one party has not performed).
b. Executed Contract
A contract is executed if all of the duties under the contract have been
performed.
Sources of Contract Law - Common Law and the UCC
1. Common Law - No\\-seI\le -
The common law is generally derived from courts. Contracts involving Real Estate,
Insurance, Services and Employment (R.I.S.E.) are governed by the common law.
2. Uniform Commercial Code (UCC) Sales Article
The UCC is statutory law that has been widely adopted throughout the United States.
Its Sales Article (Article 2) governs contracts for the sale of goods (moveable things).
An agreement made up of an offer and an acceptance;
II. CREATION OF A CONTRACT
A. Elements in General
Generally, there are three requirements of a legally enforceable contract:
[
i)
t--\etMovil.e! (ii) An exchange of consideration (something of legal value); and
(iii) A lack of defenses.
If these three requirements are met, there is an enforceable contract and remedies are
available if one party breaches (i.e., does not perform as promised).
PASS KEY
Notice that "a writing" is not a general element of a contract. Certain contracts must be evidenced by a
writing (they will be discussed in this chapter under the Statute of Frauds portion of the Defenses section),
but the general rule is that a writing is not required. Thus, if you see an answer choice on the exam saying an
offer or acceptance must be in writing, scrutinize the facts carefully. If the contract is not within the Statute
of Frauds or the offer is not a merchant's firm offer (discussed later), the choice probably is wrong.
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B. Agreement (Mutual Assent) - Offer and Acceptance


Mutual assent is often said to be agreeing to the "same bargain at the same time"-
a meeting of the minds. Generally, one party will make a proposal (an offer) and the other
party will agree to it (an acceptance).
PASS KEY
Roughly one-third of the contracts questions involve offer and acceptance issues. Thus, you should take your
time to master the concepts below.
1.
O-P-Pevov - tMc:l\\::.es
o.p.pev
O-P-Pevee - veCelVeS
o.p.pev
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E)CfveSS - oVc:l\l ov 110'1111
The Offer
-
An offer is a statement by an offeror that creates the power of acceptance in the
receiver offeree-essentially, the power to form a contract by accepting before the offer
is terminated. To be an offer, the communication must create a reasonable expectation
in the offeree that the offeror intends to make a contract. Three questions should be
considered:
[
i) Was there a manifestation of intent to contract?
MetMOVlz.e! (ii) Was there definiteness and certainty in the essential terms?
(iii) Was there communication of the above to the offeree?
a. OntenOto Make a Contract - ObViOL\S jo\c.e is "oi- eI\"
To be valid, the offer must be sufficient for a reasonable person to assume that
the offer was a serious offer to contract. The offeror's subjective intent (i.e.,
whether the offeror thought (s)he was making an offer) is irrelevant. Contract law
generally follows an objective theory (would a reasonable person believe the
offer was serious). Statements made in jest or frustration and understood as
such by a reasonable person are not offers.
(1) Advertisements - GenerallyB:>ffers
Widely distributed statements such as advertisements are not offers
because they are not addressed to anyone in particular. They are usually
considered only to beOnvitations};eeking offers.
EXAMPLE
Steve places an ad in a local paper announcing the grand opening of his store and
quoting the price of certain items. Such an ad is not an offer but is only an invitation
seeking offers.
ANCILLARY MATERIAL (for Independent Review)
(a) Exception - Specifying Offeree
An advertisement that limits the scope of the persons who can
accept (e.g., "the first five customers can buy this coffeemaker for
only $1 ") will be considered to be an offer.
END OF ANCILLARY MATERIAL
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b.
<
vee - qL\eI\"i-ity
Terms Must be Definite and Certain - el\11 i-eV'lMs
An offer must be definite and certain in its terms. What is essential depends on
the type of contract involved. An offer for the sale of goods generally need only
include the quantity term (e.g., "1 offer to sell 100 widgets"). An offer to create a
contract under common law (e.g., a contract involving services or real property)
must include:
(i) The identity of the offeree and the subject matter;
(ii) The price to be paid;
(iii) The time of performance;
(iv) The quantity involved; and
(v) The nature of the work to be performed.
EXAMPLE
Alex asks Bob to repair a broken window at Alex's store within three days, at a price to be
agreed upon later. The offer here will fail for indefiniteness of the price term.
c. Communication to Offeree - No "0 el\ccepi-eI\"ce
To have the power to accept, the offeree must have knowledge of the offer.
Therefore, the proposal must be communicated to him.
EXAMPLE
Alex returned to Bob his lost briefcase unaware that Bob had placed an advertisement offering
a $20 reward for its return. Since the offer had not been communicated to Alex, there could
not be mutual assent. Hence, there is no contract and Bob is not obligated to pay the reward.
Revocation by Offeror
-
The general rule is that the offeror can revoke an offer any time before
acceptance by communicating the revocation to the offeree. (ExcepOas - vee .plv",", o-P-Pev
discussed below, this is true even where the offeror promises he will keep the
offer open.
2. Termination of Offer -"3 WeI\YS
To create a contract, an offer must be accepted before it is terminated. An offer can be
terminated in a number of ways-through the act of either party (offeror: revocation;
offeree: rejection) or by operation of law (e.g., by death of a party).
1_I
CDa
.
EXAMPLE
Maurice sent Schmit a telegram offering to sell him a one-acre tract of commercial property for
$8,000. Maurice stated that Schmit had three days to consider the offer and in the meantime
the offer would be irrevocable. The next day, Maurice received a better offer from another
party, and he telephoned Schmit, informing him that he was revoking the offer. This was an
effective revocation.
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OVeI\l/wvlH-e\\
(1) May be Direct or Indirect - CO\\AL\ci- - sell i-o SOtMeo\\e else
The revocation can be direct (e.g., a phone call to the offeree withdrawing
the offer) or indirect, where the offeree receives correct information the
offeror no longer wants to make the offer.
EXAMPLE
Alex offers to sell his car to Bob for $500. Bob tells Alex that he wants to think about it.
The next day, Carol, a friend of Bob, drives over to Bob's house to show Bob the car she
just purchased from Alex. The offer to Bob is revoked.
(2) Revocation by Publication
Offers made by publication may be terminated by publication of revocation
through comparable means.
EXAMPLE
An offer published in the New York Times may be revoked by publication in the New
York Times. It may not be revoked by publication in Reader's Digest or by a TV spot.
(3) Effective when Received
The revocation is generally effective when received by the offeree. Where
revocation is by publication, it is effective when published.
(4) Limitation on Offeror's Power to Revoke
Although the general rule is that all offers can be revoked. there are three
exceptions to the general rule which appear with some frequency on the
CPA exam: (i) where consideration is paid to keep the offer open (called an
option contract); (ii) a substantial start on a unilateral contract); and (iii)
merchant's firm offers under the UCC.
E"ceptlo\\s: (a) (Option Contract) - lvvevocel\ble o ~ ~ e v
An option is a distinct contract in which the offeree gives
consideration to keep the offer open.
ANCILLARY MATERIAL (for Independent Review)

(b) Unilateral Contracts


If an offeror makes an offer to enter into a unilateral contract and the
offeree begins to perform, the offeror cannot revoke and must give
the offeree a reasonable time to complete performance.
(c) Merchant's Firm Offers under UCC Sales
Certain written offers by merchants are irrevocable under the UCC.
Such offers will be discussed under Sales.
END OF ANCILLARY MATERIAL
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EXAMPLE
(1) Ann sends Barb an offer to sell a parcel of land for $60,000. The offer states that it will not be
withdrawn for 60 days. Ten days later, Ann calls Barb and tells Barb that she is revoking the offer.
The next day, Barb sends Ann a letter of acceptance. There is no contract because the offer was
revocable (no consideration was given to keep the offer open). It was revoked before Barb
accepted.
(2) Same facts as above except the offer stated that Ann would keep the offer open if Barb promised
not to sue Ann for 60 days on an unrelated dispute, and Barb agrees not to sue. There is a contract
here because (as will be explained later) forbearance to sue is valid consideration. Thus, an option
was created, so Ann's offer could not be revoked for 60 days; Ann's attempted revocation was
ineffective and Barb's acceptance was effective.
PASS KEY
The examiners frequently use irrevocability as a wrong answer choice. They will tell you about the
parties' negotiations as in the examples above, and ask you to pick a true statement. One answer
choice frequently is that the offer is "irrevocable" or "it could not be revoked because it is an option."
Scrutinize the facts carefully. The key point to remember is that if consideration was not given to keep
the offer open, it is not an option.
IM.I b.
Rs-8
Rejection by Offeree
The offeree can terminate the offer by rejecting it. Once the offer is effectively
rejected, it cannot be accepted.
(1) Method - Express Rejection or Counteroffer
The offeree can reject expressly (e.g., by saying "no"). But more
interestingly, a{counteroffer)s also considered to be both a reiection (which
terminates the original offer) and an offer (of which the original offeror is
now the offeree who may accept or reject).
EXAMPLE
(1) Alex offers to sell Barb his car for $450. Barb says "no." The offer is terminated. If
Barb later has a change of heart and tells Alex "I accept," Barb has at most made a
new offer. No contract is created.
(2) Alex offers to sell Barb his car for $450. Barb says "No, but I'll give you $425." Barb
has rejected and made a new offer through a counteroffer.
(a) Distinguish Mere Inquiry
It is not a counteroffer, and therefore is not a rejection, to "feel the
other party out" by questioning.
EXAMPLE
Alex offers to sell Barb his car for $450. Barb asks Alex if he'd consider taking
$425. Alex says no. Barb accepts the car for $450. There is a contract here
because Barb's statement was not a counterOffer, but rather was a mere inquiry.
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(2) Effective when Received
A rejection is effective when received.
EXAMPLE
Regulation 5
On January 3, Sam sent Ben a signed letter offering to sell his warehouse for $95,000.
On January 5, Ben wrote Sam that he would not pay $95,000 because that price was
too high. On January 6, Ben was advised that similar property had recently been sold
for $99,000. Ben immediately faxed Sam an acceptance of Sam's January 3 offer. Ben's
letter arrived the next day. There is a contract because a rejection is not effective until
received. The rejection here arrived after the offer was accepted by fax.
(3) Lapse of Time
The offeree must accept the offer within the time period specified, or if no
time period is specified, within a reasonable time. If he does not do so,
then he will have allowed the offer to terminate. An offeree's silence is
generally understood as rejection of the offer.
Termination by Operation of Law - AL\i-olMeI\tlc
(1) Termination by Death or Insanity of Parties
If either of the parties dies or becomes insane prior to acceptance, the offer
is terminated by operation of law. It is not necessary that the death or
insanity be communicated to the other party.
Exception: An option contract is not terminated by the death of a party.
EXAMPLE
Dee offered to sell Sue a parcel of land for $300,000. If either Dee or Sue dies before
the offer is accepted, the offer will terminate by operation of law. However, if Sue paid
consideration for the offer (thus creating an option contract), the offer will remain open
for the period of the option (i.e., Sue or Sue's estate could accept during the option
period and a contract would be formed with Dee or Dee's estate).
(2) Termination by Destruction of Subject Matter
If the subject matter of the offer is destroyed before the offer is accepted,
the offeree's power of acceptance is terminated by operation of law.
(3) Termination by Illegality
If the subject matter of the proposed contract becomes illegal, the offer will
terminate.
EXAMPLE
Lucky Lou offers Vegas Vernon a share in his casino business. Prior to acceptance, a law
is passed banning casinos. The offer is automatically terminated.
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3.
E)CpY'ess - "Y'(:I\l "Y' WY'l+-+-e"
The Acceptance L.ltMplleA - C""AL\Ct
The acceptance is the offeree's assent to enter into a contract. Like offers,
acceptances need not be in writing. An acceptance does not even require words-a
simple nod of the head or fall of a gavel (in an auction) can constitute an acceptance.
a. Who May Accept
The general rule is that only the person to whom the offer was made may accept.
Thus, offers are not assignable, however, option contracts are assignable.
b. Method of Acceptance
Generally, acceptance may be made in any manner reasonable under the
circumstances (e.g., a mailed offer can usually be accepted by letter, telegram, a
fax, etc.). (However) if the offeror specifies a method of communication, that
method must be used. A purported acceptance utilizing another method is a
counteroffer.
EXAMPLE
On February 1, Ann sends Bob a letter offering to employ Bob in Ann's auto dealership. On
February 5, Bob sends Ann a letter accepting the offer. On February 6, Ann has a change of
heart and calls Bob to revoke the offer. On February 7, Ann receives Bob's acceptance. A
contract was formed here on February 5, when the acceptance was sent. Ann's attempted
revocation is ineffective because it came too late (after the acceptance was sent). The date
Ann received the acceptance is irrelevant. Indeed, under the mailbox rule, a contract is formed
on dispatch even if the acceptance letter is never received by the offeror.
Acceptance Generally Must be Unequivocal
law contracts follow thelmirror image rulel which requires an vee - """
acceptance to mirror the offer to be effective. An attempted acceptance that.
changes some of the terms or adds new terms is not a valid acceptance, but tMlVV"V ltM(:I\8
e
rather is a counteroffer. vl.\le - f(:l\8e '32
Generally Effective upon Dispatch - the Mailbox Rule
c.
111111
He(:l\Yy d.

Unlike revocations, acceptances are generally effective when they are


dispatched (i.e., mailed, telegraphed, faxed, etc.) if properly addressed. This is
o-P-Pevs, known as the mailbox rule. It is irrelevant if a properly addressed acceptance is
lost or delayed. L
vev"c(:I\H",,-s (:I\,,-A
c"",,,-tev,,-P-Pevs
e-P-PecHve whe"-
vec'A.
(1) Method of Communication Specified
If the offeror required that acceptances be sent by a specific method, an
acceptance sent by that method is effective when it is sent.
(2) No Method of Communication Specified
If the offer did not state how acceptances were to be sent, an acceptance
sent by any reasonable means is effective upon dispatch (e.g., letter,
telegram, fax, etc).
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..... (3) Offeror May Opt-Out - E)Cceptlo\\ to tMeI\llbo)C V'L\le
The offeror can opt-out of the mailbox rule by stating in the offer that
acceptances must be received to be effective. In such cases, the
acceptance must be received before the offer terminates.
EXAMPLE
On November 1, Dee sent Steve a fax offering to sell Steve a vase. The offer provided that an
acceptance must be received by 5:00 on November 2. At 3:00 on November 1, Steve sent Dee
an acceptance by overnight mail, but the acceptance did not reach Dee until November 3.
There is no enforceable contract because the acceptance came too late. The offer provided
that the acceptance had to be received by 5:00 on November 2, so the mailbox rule does not
apply.
PASS KEY
You probably will see a mailbox rule question on your exam. Often it is coupled with a
revocability issue as in the example on the preceding page. The key is to approach such
questions in three steps:
(i) Was the offer revocable? Chances are it was, unless the offeree paid consideration to keep
the offer open (an option) or the offer is a firm merchant's offer for the sale of goods.
(ii) Determine whether the mailbox rule applies (i.e., acceptance is effective on dispatch
rather than receipt, unless it stated that an acceptance had to be received to be effective).
(iii) Compare any effective revocation date with the effective acceptance date. If a revocation
was effective first, the offer was terminated and there is no contract. If the acceptance
was effective first, there is a contract and the revocation was ineffective.
Be sure to remember, the mailbox rule only makes acceptances effective on dispatch;
revocations, rejections, and counteroffers are effective only upon receipt.
Consideration
Consideration is the price of contracting.IBoth sideslof the contract must be supported by
legally sufficient consideration. The law will not enforce gratuitous promises. Something
must be given in exchange for a promise for it to be enforceable.
o ~ e V ' $/
el\cceptel\\\ce
C.
1. Elements of Consideration
There are two elements of consideration: there must be something of legal value given
by each party and there must be a bargained for exchange.

a. Element of Legal Value


Something is of legal value if it constitutes either a detriment to the
promisee or a benefit to the promisor. That is, the promisor's promise is
supported by consideration only if the promisee agrees to do something he or
she is not already obligated to do (a detriment) or the promisor will obtain some
benefit. Possible items of consideration include promises to perform acts or to
refrain from performing, promises to pay money, and promises to give land,
goods, stock, etc.
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EXAMPLE
Phil (promisor) agrees to sell Lori (promisee) his television set for $200. Phil's promise (to
sell) is supported by Lori's detriment (the giving of $200). Note that consideration must be
present on both sides; each party to a contract is both a promisor and a promisee. Thus,
Lori's promise (to give $200) is supported by Phil's detriment (giving the TV).
(1) Need@iave Monetary Value
Consideration need not have monetary value. As long as the promisee is
promising to do something that he is not already obligated to do or
promising to refrain from doing something that he legally could do, there is
consideration.
(2) Need@D=low to Party
Note that the consideration need not flow to one of the parties; it is 27
sufficient to promise to do something for or give something to a third party.
EXAMPLE
(1) Father promises Daughter that he will give Daughter $500 if she names her first-born
son after Father. Daughter does so. Naming the son after Father is valid consideration.
(2) Joanne promises Keith that she will refrain from suing Keith for 60 days on a valid claim
if Keith promises to give Joanne an option to purchase Keith's property for a specified
price during the 60-day period. Both promises constitute consideration. (Joanne's
promise is known as a forbearance to sue.)
(3) Alex promises Becky that he will pay her $10 if she promises to wash Cindy's car. Alex's
promise is sufficient consideration to support Becky's promise even, though Cindy will
receive the benefit.
(3) Courts into Adequacy FeI\lV\\eSS \\oi- veqL\lveA
As long as the consideration is not a sham, courts will not inquire into the
adequacy of consideration (i.e., they will not compare the relative values of
the consideration exchanged). There is no requirement that the
consideration exchanged be of nearly equal value. The only requirement is
that the consideration be legally sufficient, which means of legal value, as
discussed above.
(4) Preexisting Legal Duties Generally Not Sufficient
A promise to perform, or performance of, an existinq duty is not sufficient
consideration. Note that this means in common law contracts the price
term cannot be modified unless consideration is given for the modification.
However, as will be discussed, the rule is different in Sales contracts.
EXAMPLE
(1) Carol is under a contract to sing at a concert for Mike. Carol decides she does not want
to sing. To entice Carol to sing, Mike offers to pay Carol $5,000 more if she will sing.
Carol agrees and sings. Mike does not have to pay Carol the additional $5,000. There
was no consideration for the promise because of the preexisting legal duty rule-Carol
was already obligated to sing.
(2) Smith offers a $10,000 reward for recovery of his kidnapped daughter. Jones, a police
officer assigned to this case, recovers the daughter. Jones's performance of his official
duty is not sufficient consideration.
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vee - (a)
o\\ly
Exception - New or Different Consideration Given INeeAeA to
If each party offers to give something different from what was
originally promised-no matter how trivial-the courts will usually
enforce the promise despite the preexisting legal duty rule.
EXAMPLE
Same facts as in example (1), above, except Carol offers to sing five minutes
longer than she was originally obligated to. The modification is binding.
(b) Honest Dispute as to Duty
If the scope of the legal duty owed is the subject of honest dispute,
then a modifying agreement relating to it will ordinarily be given
effect. This is because the parties are giving up their right to sue to
have the dispute settled, and forbearance to sue is valid
consideration.
b. 'IOlAV pvolMlselel\ct l\\AlAceA lMy pvolMlselel\ct
Something is not consideration unless it was given in exchange for other
consideration-a bargained-for exchange of consideration.
(1) Gift - No IIfflilI
Promises to make a gift are unenforceable because of lack of
consideration. There is no bargained-for exchange with a gift.
(2) "Past" or "Moral" Consideration - lllM
If something had already been given or performed before the promise was
made, it will not satisfy the "bargain" requirement. The courts reason that it
was not given in exchange for the promise when made.
EXAMPLE
A loose piece of molding fell from a building and was about to hit Sam. Sherry, seeing
this, pushed Sam out of the molding's path and was herself struck by it and seriously
injured. Sam promised Sherry that he would pay her $100 per month for life. There is
no consideration.
c. (Exception)Detrimental Reliance/Promissory Estoppel - t)O\\eI\te to Chel\Vlty
Like most rules of law, there are exceptions to the requirement of consideration.
The exception most likely to arise on your exam involves detrimental
reliance/promissory estoppels. Under the doctrine of promissory estoppel or
detrimental reliance, a promise made by one party and detrimentally relied upon
by another can be enforced without consideration. For the doctrine to apply the
promise must be reasonably relied upon and detrimental (the party relying on the
promise was substantially harmed).
EXAMPLE
Richie Rich hears that his local hospital needs a new MRI machine. He calls the hospital and
promises to donate $100,000 to enable the purchase. Richie's promise is not supported by
consideration; it is an offer to make a gift. However, if the hospital detrimentally relies on the
promise by ordering an MRI machine, Richie will be bound.
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D.
No l\\\\oce\\i- Pel\V'Ty'S AlATy i-o
Defenses
Defenses can make a contract unenforceable. Two defenses have already been
discussed-lack of an agreement and lack of consideration. There are a number of other
defenses that the examiners often test.
PASS KEY
Defenses are the most tested area in contracts. Pay close attention to the detail below. One key to choosing
the correct choice is to remember that very few defenses make a contract void (unenforceable by either
party). Most defenses make a contract only voidable (it may be avoided at the option of the party adversely
affected). Thus, if you see a choice that says a contract is void, be careful-chances are good that the choice
is incorrect.
1. Fraud
A contracting party can establish the defense of fraud if (s)he can prove:
(i)
a.
(ii)
(v)
(iv)
(iii)
A@srepresentation of@)terial fact;
@ienter (knowing that the statement was false or made with a reckless disregard
for the truth);
An intent tC@duce plaintiff's reliance on the misrepresentation;
@:tual and justifiable (reasonable) reliance by the plaintiff on the
r+'\TeI\llAe"
Must be a Material Fact Not Usually Count
The misrepresentation must be of a material fact. Opinions or statements of
value do not constitute facts unless made by experts.
b. Scienter - Intent to Deceive
tw\etMoV'lz.e!
Fraud is an intentional tort. The misrepresentation must be made with scienter,
an intent to deceive. This means the defendant must make it knowingly or
intentionally. The intent to deceive element can also be fulfilled by making the
misrepresentation with a reckless disregard for the truth. This is called
constructive fraud or gross negligence.
c. Intent to Induce Reliance
The purpose in making the misrepresentation was to induce reliance.
d.
e.
Reasonable Reliance - I\\Aepe\\Ae\\Hy chec\c.
The plaintiff did actually and reasonably rely on the misrepresentation.
Damages - COtMpe\\SeI\i-oV'y eI\\\A plA\\lT-lVe
The defendant is liable to anyone who suffered a loss. The defrauded party may
rescind the contract or sue for money damages, but not both.
Rs-14
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2. Fraud in the Execution and Fraud in the Inducement

Fraud can also be categorized by whether or not the defrauded party knew a contract
was being made.
a. Fraud in the{Execution) Vo'i.A
Fraud in the execution occurs when a party is deceived into signing
something that he does not know is a contract (e.g., where a ball player signs
what he thinks is a fan's autograph book but is in fact a contract). Fraud in the
execution makes a contract void, not voidable because there is no "meeting of
the minds."
..
Fraud in theQnducement) Vo'i.AeI\ble
With fraud in the inducement the defrauded party is aware she is
making a contract, but4erms)are materially misrepresented. Most fraud is fraud
in the inducement and it makes a contract voidable.
b.
3. Innocent Misrepresentation - tw\AIV
An innocent misrepresentation has all the elements of fraud{except scienter) The
misrepresentation is made innocently, not intentionally.
4. Duress
Duress arises when a party's free will to contract is overcome by an unlawful use of a
threat of harm. If the harm threatened is physical force (e.g., "sign the contract or I'll
blow your head off'), the contract is(void) If the harm threatened is economic or social
(e.g., "I'll fire you if you don't sign the contract" or "I'll divorce you if you don't sign the
contract"), then the contract is{voidable) However, merely taking advantage of the
other person's economic condition to negotiate a favorable contract (if no threat is
involved) does not constitute duress.
5. Undue Influence - -r eI\ velel\i-'i.o\\sh'i.p
In the case of undue influence a party's free will to contract is overcome by the
defendant's abuse of a position of trust or confidence. The person in the position of
trust or confidence (e.g., a spouse, trustee, guardian, attorney. etc.) uses the position
to take advantage the other's weakness, infirmity, or distress.
EXAMPLE
Lawyer convinces Client, a senile person, to sell Lawyer Client's personal property. An undue influence
defense will likely succeed.
6. Mutual Mistake
IfQjoth)parties to a contract are mistaken as to a material fact regarding the contract,
the adversely affected party can avoid the contract. Note, however, that this rule
generally does<6QDapply to mistakes as to value, because value generally is
considered to be a matter of opinion.
EXAMPLE
Alex and Bob enter into a contract for Alex to buy and Bob to sell Bob's Rolex watch for $200. Before
the sale is complete, the parties discover that the watch is a fake Rolex. Alex may avoid the contract.
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Regulation 5
a.
Becker Professional Education I CPA Exam Review
Nonexistence of Subject Matter - ContractCVoid) AesTvoyeA
If the subject matter of the contract is not in existence when the contract is made
and neither party knows this, the contract is void.
EXAMPLE
Ann enters into a contract with Barb to purchase Barb's car for $1,000. Unbeknownst to either
party, the car was destroyed by a fire earlier in the day. There is no contract-the contract is
void.
7. Unilateral Mistake -
Generally, a unilateral mistake (i.e., a mistake by one party) is not a defense to a
contract. There is one major exception that the examiners like to test-a unilateral
mistake as to a material fact is a defense if the other party knew or should have known "BiAs"
of the mistake.
EXAMPLE
(1) Sue enters into a contract with Tyler to sell Tyler a parcel of land. Sue knows that the land cannot
support a building taller than five stories, but most of the buildings in the area are only three
stories. Unbeknownst to Sue, Tyler intends to build a 20-story building on the land. Tyler's
unilateral mistake (as to suitability of the land) is not a defense. However, if Tyler showed Sue the
plans to the bUilding before the sale and Sue remained silent, the defense of unilateral mistake is
available.
(2) Phil is selecting bids from contractors for construction of a garage. One bid is substantially lower
than the others (e.g., bid 1-$6,000; bid 2-$5,600; bid 3-$3,200) so that it is obvious that there is a
mistake in the bid. The mistake will be a defense. Note that the bidder's negligence is irrelevant.
8. Illegality - Contract Generally(Void)
If the consideration or the subject matter of a contract is illegal, the contract generally is
void. Examples of illegality include agreements to commit a crime or tort (e.g., to steal
and sell an employer's trade secrets); agreements in restraint of trade; gambling
contracts; usurious contracts; etc.
EXAMPLE
Joe enters into a contract with Jim to kill Jason in exchange for 10 kilos of cocaine. The contract is void
both because the subject matter (to kill) is illegal and the consideration on the other side (cocaine) is
illegal.

a.

(Licensing} Revenue Raising vs. Protection - No hce"se, "0 - VOlA
If a contract is illegal because a party does not have a required license,
enforceability of the contract depends on the reason for the license.
(1) Failure to have a license required to protect the public (e.g., GPAs,
attorneys, doctors, realtors, etc.) makes a contract void. Even if the
unlicensed party performs the contract, he cannot collect.
(2) If the license is required merely to raise revenue (e.g., all vendors at a fair
pay a $25 license fee) the contract is enforceable.
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Becker Professional Education I CPA Exam Review Regulation 5
b. Promises Not to Compete Reasonable)
Most romises not to compete are illegal because they violate Antitrust law.
However promises not to compete in employment contracts and in the sale of a
business are enforceable if they meet three tests of reasonableness:
(1) The promise must be reasonably needed to protect a legitimate business
interest, No Tvel\Ae secvei-s
(2) The promise must be reasonable in duration,
(3) The promise must be reasonable as to distance (geographic scope).
EXAMPLE
Andy, an accountant practicing in a small town, sells his practice to Dee and agrees not to
solicit former clients or practice within five miles of town for two years. The agreement is
enforceable.
9. Minors May Generally Disaffirm Contracts - CeI\\\cel
A minor (usually a person under the age of 18) may disaffirm a contract anytime while a
minor or even within a reasonable time after becoming an adult. The minor must
generally return whatever she possesses when she disaffirms.
EXAMPLE
Bob, a 16-year-old, purchased a used car from Paul. Ten months later, the car was stolen and never
recovered. Bob may disaffirm the contract and get his money back.
a. Exception - Contracts for{Necessities)
A minor will be bound on his or her contracts for necessities of life, including
food, clothing, and shelter. What is necessary is determined by the minor's
station in life (i.e., the minor's standard of living).
b. Ratification on Reaching Majority O\\ly
A person can become bound on the contracts he or she enters into as a minor
upon reaching the age of majority by ratifying the contract. A contract may be
ratified by:
(i) Failing to disaffirm within a reasonable time after reaching majority;
(ii) Expressly ratifying the entire contract orally or in writing; or
(iii) Retaining or accepting the benefits.
Note that ratification is all or nothing; a person cannot ratify part and reject part.
Also, such ratification does not require consideration. Finally, note that it is the
minor who has the right to disaffirm; the adult does not have a right to rescind
merely because the minor may disaffirm.
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Regulation 5 Becker Professional Education I CPA Exam Review
10. Intoxication
Intoxication is a defense to a contract only if the intoxication prevents the promisor from
knowing the nature and significance of his or her other party knew of
the impairment.
EXAMPLE
Rick and Steve have a drink at lunch and then enter into a contract. Neither party is
impaired. The contract is enforceable.
11.
12.
I-I
Heel\Yy 13.
I-I
Mental Incompetency -Incapable of Understanding Contract GR: vo'i..::AeI\ble
A contract made by a party whose mental capacity is so deficient that (s)he is not
capable of understanding the nature and significance of the contract can be disaffirmed
(i.e., the contract is voidable). C3owever)a contract made by a party after (s)he is
adjudicated mentally incompetent isGQ@)
Statute of Limitations
Statutes of limitations provide that a legal action must be commenced within a certain
period of time. Generally, if the statute of limitations period has expired on a contract, it
is unenforceable. It does not make a contract void, but merely bars access to judicial
remedies.
a. Four to Six Years
Although contracts statutes of limitations vary, four to six years is typical.
b. Measured from Date of Breach
Actions for breach usually are measured from the time the cause of action
accrued (i.e., the date of the breach).
Statute of Frauds - Six Contracts Requiring a Writing by to be
Although the general rule is that contracts need not be in writing, six contracts require
some type of writing to be enforceable. Both parties need not sign the writing. Only
the party to be charged (i.e., the party trying to avoid the contract) must sign.
MelMOVlz.e!
(i)
(ii)
@ (iii)
(iv)
(v)
(vi)
Contracts where the consideration is marriage (e.g., "if you get married, I'll buy
you a house");
Contracts which by their terms cannot be performed within a year (e.g., "I will
coach your football team for the next five years");
Contracts involving interests in land (this includes all contracts for the sale of an
interest in real property-such as a contract for the sale of a house or a
warehouse-and leases of real property of more than a year);
Contracts by executors or similar representatives to pay estate debts out of
personal funds;
Contracts for the sale of(OO{1S)for $500 or more; and
Contracts to act as surety (i.e., to pay the debt of another).
Rs-18
It is very important to memorize these six types of contracts because the examiners
frequently test which contracts require a writing.
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PASS KEY
Regulation 5
One key to memorizing the six categories is the mnemonic device "MYLEGS" (marriage, year, land, executors, goods, and
suretyship). Contracts for services can be oral regardless of price so long as they can be completed within one year.
ANCILLARY MATERIAL (for Independent Review)
a. Year Contracts - Measured from the Date of the Contract
Contracts that cannot be performed in one year must be evidenced by a writing.
In determining if a writing is required, the one-year period runs from the date of
the contract, not from when performance begins. Thus, a contract to wash a car
two years hence requires a writing.
(1) Exception - Possible to Perform in a Year
Only contracts impossible to perform in one year require a writing. For
example, a contract to work for an employer for life need not be in writing
since the employee could die the next day.
(2) Exception - Full Performance by One Party
If one party has fully performed the contract, it need not be evidenced by a
writing even if impossible to perform in one year.
b. Land Contracts Must be Evidenced by a Writing
(1) Exception - Leases for Less than a Year
Leases of land for less than a year do not require a writing.
(2) Exception - Full or Partial Performance
Oral contracts involving land can be enforceable if a party has fully or
partially performed. Most states require two of the following:
(i) payment in whole or in part; (ii) making valuable improvements on the
land; and (iii) possession of the land.
END OF ANCILLARY MATERIAL
Not seVVlces
c. (Goods)for $500 or More
Contracts for the sale of goods of $500 or more must be evidenced by a writing.
If a sales contract has been modified, it is the contract as it has been modified
that determines whether a writing is required.
EXAMPLE
Ann offers to buy 200 books from Ben at $3 each, to sell in her store. This contract must be in
writing. Subsequently, Ann discovers that she has room for only 150 books and so calls Ben
and asks if her order can be reduced. Ben agrees. The contract need not be in writing.
Conversely, if the contract were for 150 books and then was modified to 200 books, a writing
would be required.
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Regulation 5
Rs-20
Becker Professional Education I CPA Exam Review
PASS KEY
The examiners often try to trick you with the $500 threshold. It applies only to goods contracts. A
$200 land contract must be evidenced by a writing, so must a $400 three-year service contract, etc. If
you see $500 in an answer choice, be careful. If the contract does not involve the sale of goods, the
choice is probably wrong.
d. Suretyship
A promise to pay the debt of another must be evidenced by a writing but only if it
is collateral to the other's promise to pay; if it is a primary promise to pay, it is not
a suretyship promise.
EXAMPLE
Bob says, "Give Ann the goods, and if she does not pay, I will." This promise must be in writing
because it is a collateral promise to pay another's debt.
EXAMPLE
Bob says, "Give Ann the goods and Jwill pay." This promise need not be in writing because it is
a primary promise to pay; it is not collateral to a promise by Ann.
e. What Writing Will Suffice
The "contract" itself need not be in writing; all that is required is some writing that
provides evidence of the material terms of the contract that is signed by the
person being sued. Thus, a letter about the contract could suffice. Contracts for
sale of goods generally need only have a quantity term and a signature. The
terms may be stated in more than one document. There is no requirement that
all terms be stated in a single writing.
PASS KEY
Remember the signature you're looking for is the signature of the person being sued. The
other party's signature is not needed and will not do.
f. Effect of Noncompliance
Failure to satisfy the Statute of Frauds does not prevent the formation of a
contract; rather, it makes the contract unenforceable by one or both of the
parties.
14. Impossibility
If after the parties enter into a contract an event occurs that will make performance of
the contract objectively impossible (i.e., impossible for anyone to perform), impossibility
is available as a defense. The defense discharges the adversely affected party from
any further duty to perform. Note that a mere increase in the cost of performance does
not make performance impossible. V P ~ 0\\ sTv'i.\c.e - lASe FeAE)C
EXAMPLE
Alex contracts with Phil to have Phil manufacture at his factory 1,500 wrenches. Fire then destroys the
factory. Phil has the defense of impossibility because no one can make wrenches at Phil's factory since
it is now destroyed.
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COMPARE
Regulation 5
Alex contracts to buy 1,500 wrenches from Phil, a tool wholesaler. Phil's warehouse, full of tools, is
then destroyed by fire. Phil must still supply Alex because performance is not objectively impossible;
Phil can purchase more wrenches to sell to Alex.
a. Destruction of Subject Matter
If the subject matter or the specified source of the subject matter of the contract
has been destroyed, the contract may be avoided due to impossibility.
EXAMPLE
Tyler enters into a contract to repair Steve's boat. Before the boat can be repaired, it is
destroyed by fire. The parties can avoid the contract on impossibility grounds.
b. Death of the Party to Perform Services
Death or incapacity of a person to perform a personal service contract will
discharge the contract due to objective impossibility.
EXAMPLE
Dee contracts to have Bob, a famous ball player, sign autographs at Dee's store. Bob then dies.
Bob (or his estate) has the defense of impossibility. Note that this is objective, not subjective,
impossibility since the contract called for Bob to sign, and there no longer is a Bob.
15. Accord and Satisfaction and Substituted Contract
I-I
An accord is an agreement to substitute one contract for another, and
satisfaction is the execution of the accord. Accord and satisfaction discharges the
original duty. Until the accord is satisfied a party may sue under the original contract or
the accord. A substituted contract is very similar to an accord and satisfaction case,
but the duties under the original contract are discharged immediately.
EXAMPLE
Alex agrees to sell his car to Steve for $450. The parties agree to substitute a contract for the sale of
Alex's bike to Steve for $100. The new agreement is the accord, when it is performed is the
satisfaction.
16. Novation
Novation is available as a defense to a party who has been released from a
contract. It occurs when a new contract substitutes a new party for an old party in an
existing contract. All parties must agree to the release.
EXAMPLE
Sue agrees to build a garage for Barb, but then gets a more lucrative construction job. Sue asks Barb if
it's okay to substitute Dee to build the garage. The parties agree to substitute Dee and release Sue.
There has been a novation.
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Regulation 5
ANCILLARY MATERIAL (for Independent Review)
Becker Professional Education I CPA Exam Review
a. Compare Release
A release or agreement to discharge one of the parties without replacing that
party is not a novation but rather a simple release. Such an agreement usually
requires new consideration or detrimental reliance to be enforceable.
17. Conditions Can Affect a Party's Duty to Perform
A condition is an event, the occurrence or nonoccurrence of which will end a party's
duty to perform. Conditions have different names depending on when they occur.
Conditions are often preceded by "if," "subject to" or similar language.
EXAMPLE
"I will pay you $10 if you mow my lawn." Mowing the lawn is an express condition (precedent; see
below) to payment of the $10.
a. Condition Precedent
A condition precedent is a condition that must occur before the other party must
perform.
b. Condition Concurrent
Conditions concurrent are conditions that must occur simultaneously. For
example, the payment of money and exchange of goods in a sales contract are
conditions concurrent. The parties make the exchange simultaneously.
c. Condition Subsequent
A condition subsequent is a condition that will occur after a party's duty to
perform has arisen and will cut off that duty.
EXAMPLE
"I will pay you $100 per year until the Bears win their third Super Bowl." Upon the Bears
winning their third Super Bowl (as if that would ever happen), the duty of payment is cut off.
END OF ANCILLARY MATERIAL
"\n."Aevs"
18. Prevention of Performance is a Breach
If one party prevents the other from performing contract duties, a material breach has
occurred. The nonbreaching party is excused from performance.
Rs-22
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it, L\"AevstooA it to its tevtMS
19. Parol Evidence Rule
The parol (oral) evidence rUleC?rohibits)
A party in a lawsuit involving a fully integrated written contract (i.e., a written
contract that appears to be intended to reflect the entire agreement between the
parties);
From introducing evidence at trial of:
.;:. Oral or written statements made prior to the written contract or oral statements
made contemporaneously with the written contract;
.;:. That seek to vary the terms of the written contract.
Note that evidence not seeking to vary the terms (e.g., fraud, mistake, lack of legal
capacity, etc.) is admissible.
EXAMPLE
Bob, a 16-year-old, is looking at cars on Lori's used car lot. Lori tells Bob that if Bob buys a car today,
Lori will wash the car once a week at no charge for a year. Bob selects a car and the parties sign a fully
integrated agreement setting out the parties, the price, the warranty, etc., but failing to mention
anything about the washing agreement. Assuming Lori's statement was not fraudulent (e.g., she
actually intended to provide the washings when she made the statement but later changed her mind),
Bob will not be able to introduce evidence ofthe statement in court. However, the parol evidence
rule would not prohibit Bob from introducing evidence of his age, since that is not seeking to vary the
contract's terms.
A#ev
a. (Subsequen9Modifications Admissible
Oral or written modifications made after the contract has been entered into
(subsequent modifications) are admissible.
b. Evidence Admissible to Explain Ambiguous Terms
Even if there is an integrated written contract, parol evidence is admissible to
show the meaning of an ambiguous term.
c. Evidence Admissible to Show Fraud, Duress, or Mistake
Even if there is an integrated written contract, parol evidence is admissible to
show fraud, mistake, duress or similar because such evidence does not seek to
vary the terms, but rather seeks to show something collateral to the contract that
affects its enforceability.
PASS KEY
The examiners often ask parol evidence questions. There are two key areas to examine:
Examiners love to test the time element in parol evidence rule questions. Remember that prior or
contemporaneous statements that contradict the writing are inadmissible. Subsequent
statements that contradict (or change a term) are admissible.
Examiners sometimes combine the parol evidence issue with a Statute of Frauds issue, usually in
an oral modification fact pattern. The key is to address each issue separately. First determine
whether the modification is enforceable (is the contract as modified within the Statute of Frauds).
Then determine whether it is admissible in evidence (subsequent modifications are admissible)
under the parol evidence rule.
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Regulation 5 Becker Professional Education I CPA Exam Review
ANCILLARY MATERIAL (for Independent Review)
20. Unconscionability
Unconscionability is a doctrine used by courts to refuse to enforce provisions of a
contract, or an entire contract, based on notions of fairness. It usually is used only
when a clause or a contract is extremely unfair and the party having the benefit of the
unfair term had substantially superior bargaining power.
END OF ANCILLARY MATERIAL
III. REMEDIES
A. In General
One of the last contracts issues remaining is what to do when a party fails to perform
something he or she is contractually obligated to do, i.e., what to do when there is a breach.
This is the province of remedies.
B. Breach
1. Materia or Substantial Breach VS. tMl"-"V r - IIz.ev,,'1
vee pev-Pec+ At common law if there has been a material or substantial breach, the nonbreaching
te,,-.J.ev vl.\l e party can be discharged from the contract. If the breach is only(minor) the
45"" nonbreaching party is not discharged, but is entitled to damages.
2. Anticipatory Repudiation or Early Breach
I-I
Rs-24
Anticipatory repudiation occurs when one person unequivocally indicates in advance of
performance to another that she will not perform contractual duties when the time
comes. The nonrepudiating party has the following options:
a. Treat the repudiation as a breach and immediately sue for damages (she need
not wait until the time specified for performance to sue);
b. Ignore the repudiation, await the time for performance, and then sue if the
repudiating party has not performed;
c. Cancel the contract.
The repudiating party has the right to withdraw the repudiation until the other party
relies (e.g., by bringing suit).
EXAMPLE
Alex has contracted to manufacture 1,000 wrenches for Becky within the next 60 days. On day 40,
Becky discovers that Alex has not begun performance (which is not anticipatory repudiation because
there is no unequivocal indication that Alex won't perform). Becky calls Alex, and Alex tells Becky that
Alex entered into a more lucrative contract and he won't begin manufacturing Becky's wrenches for
another 40 days. This is an anticipatory repudiation, which Becky may treat as an immediate breach.
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Becker Professional Education I CPA Exam Review Regulation 5
C. Damages $ I"hUMSI
Once there is a breach, the next step is to determine the damages to which the
nonbreaching party is entitled. Numerous damage measures are set out below, but the key
to all of them is that they are intended to put the nonbreaching party in as good a position as
he would have been had there been no breach.
PASS KEY
Even if you can't remember a specific remedy measure, remember the goal of contract remedies and you
should be able to pick the correct choice in most damages questions.
1. Compensatory Damages - Benefit of the Bargain RIE
The standard measure of damages for personal service contracts
awards the nonbreaching party enough money to obtain substitute performance (i.e.,
the difference between the cost of substitute performance and the contract price).
EXAMPLE
Bob contracts to build a garage for Barb for $5,000. Bob gets a more lucrative construction job and
refuses to build Barb's garage. Barb hires Jim to build a garage for $6,000. Barb can collect $1,000
from Bob.
a. Consequential Damages I_I
In addition to the standard measure of damages, a party may also collect all
damages that are reasonably foreseeable as a result of the breach (e.g., extra
weathering of Barb's car resulting from no garage or extra storage fees).
1-,,1
.. . :"
b.
Liquidated Damages - Damages Agreed to in the Contract
A liquidated damage clause is a clause in a contract that specifies what damages will
be if there is a breach (e.g., forfeiture of a down payment for breach). A liquidated
damage clause is enforceable if the amount is reasonable in relation to the actual harm
done and not a penalty.
Specific Performance - Used with Land or Unique Items
Specific performance is essentially a court order that the breaching party
perform or face contempt charges. It is available if interests in land or
unique personal property (e.g., one-of-a-kind items, such as a patent) are involved. In
such cases money would be an inadequate remedy (a specific piece of property or
unique item of personal property cannot necessarily be purchased with money).
a. Cannot be Used for Personal S e r v i ~ $
Specific performance cannot be used to force a party to perform personal service
contracts (courts consider this a form of involuntary servitude).
Specific Performance@Compensatory Damages
If specific performance is available, a party can receive either specific
performance or compensatory damages, but not usually both.
3.
2.
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Regulation 5 Becker Professional Education I CPA Exam Review
IIMMI 4. Punitive Damages FV'eI\L\.::A
Punitive damages generally are not available for breach of contract. They are available
for fraud, which is a tort cause of action.
PASS KEY
Punitive damages often appear as a choice in contracts questions. It is an incorrect choice unless the
question asks which remedy is not available or the cause of action is for fraud (a tort) rather than
breach of contract.

Doctrine of Substantial Performance - V"-l,,-te,,-Ho"-eI\l tMl"-OV bveel\ch
Under thelcommon lawl a party cannot rescind or cancel if a contract has been
substantially performed. The nonbreaching party's only remedy is monetary
damages for the minor breach. However, the doctrine of substantial performance
is not available under the UCC sales article. The UCC requires "perfect tender" Goo.::As
by the seller. Under the UCC, the buyer may cancel for any breach.
Rescission or Cancellation posH-'i.O\\S"
Rescission or cancellation cancels the contract and restores the parties to their former
position. Rescission or cancellation is available for mutual or unilateral mistakes, fraud,
and most material contract breaches.
a.
I'MMtiU],II 5.
ANCILLARY MATERIAL (for Independent Review)
6. Quasi-Contract (Restitutional) Damages
If parties are discharged from a contract (e.g., because of impossibility) and one
party has already bestowed a benefit on the other (e.g., because of full or partial
performance), the court will imply a promise to return the value of the performance to
prevent unjust enrichment. The implied promise is sometimes called a quasi-
contract or restitution. This remedy is also used when there is no contract but one
party confers a benefit on another at the other's request and with a reasonable
expectation of being compensated, and the other would be unjustly enriched if he
did not have to pay for the benefit conferred.
EXAMPLE
Alex gives Bob, a famous retired ball player, $500 in exchange for Bob's promise to sign autographs
at Alex's store on a specified date. Before that date arrives, Bob dies. As discussed in the conditions
section, above, the parties will be discharged from this contract because Bob's death rendered his
performance impossible. However, the court will allow Alex to bring a quasi-contract action against
Bob's estate to recover the $500 given to Bob to prevent unjust enrichment.
END OF ANCILLARY MATERIAL
Rs-26
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Becker Professional Education I CPA Exam Review Regulation 5
B.
7. (Limitations)on Monetary Damages
In order to fairly compensate parties for harm done, the law imposes the limitations of
foreseeability and mitigation on monetary damages.
a. Foreseeability
Consequential damages are awardable only for those damages that at the time
the contract was formed a party could reasonably foresee would result from a
breach.
b. Mitigation - Reasonable Efforts to Avoid Damages
Under contract law a nonbreaching party cannot recover for damages that could
have been reasonably avoided. (S)he must mitigate damages.
IV. THIRD PARTY RIGHTS
A. In General
Until this point, we have discussed the rights and duties of the parties to a contract. But
sometimes nonparties can obtain rights under a contract. We are concerned with three such
nonparties-third party beneficiaries, assignees, and delegatees.
Third-Party Beneficiary IIMOI
Thelgeneral rulelis that only the parties to the contract have rights under the contract
(these parties are said to be in privity of contract). An exception exists for intended third-
party beneficiaries, who have rights under the contract.
1. Intended vs. Incidental Beneficiaries CeI\.""oi- e , , ~ o V ' c e
'{To be a third party beneficiary, it must be the purpose of the parties to the contract to
CeI\." give a benefit directly to the third person, the intended beneficiary. If there was no
e , , ~ o V ' c e intent to directly confer benefits, then the third party is an incidental beneficiary and has
no rights. At a minimum, the third party must be named or specifically described in the
contract.
EXAMPLE
(1) Sue contracts with Tyler for Tyler to buy Sue's car. The contract provides that Tyler pay the price
to Sue's daughter Samantha as a wedding present. Samantha is an intended third party
beneficiary.
(2) Jane hires Mike to build Jane a building. The contract specifies that Mike must use "Apex" brand
fixtures. Without more facts, Apex would not be considered an intended beneficiary. Absent
some relationship between Jane and Apex, it appears the clause was inserted only to assure the
quality of the fixtures in the building. It was not the parties' intent to benefit Apex.
(3) City contracts with Mark for Mark to provide training and jobs to City residents who are high
school dropouts. It would be unreasonable to assume the contract requires Mark to hire every
dropout. No one can qualify as a third party beneficiary because no dropout is specifically
described under the contract.
2. The Parties
The person owing the duty under a third party beneficiary contract is called the
promisor. The one bargaining for the performance is the promisee. The intended
beneficiary is either a donee beneficiary or a creditor beneficiary.
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1"i-e"AeA
- CeI\."

a.
b.
Becker Professional Education I CPA Exam Review
Donee Beneficiaries
Donee beneficiaries receive their interest as a gift (such as Samantha in
example 1).
Creditor Beneficiaries
Creditor beneficiaries receive their interest because a party owes them
something (i.e., if Tyler in example 1 was to pay Samantha because Sue owed
Samantha money).

PERFORMANCE
!
Third Party Beneficiary
THIRD-PARTY
BENEFICIARY
3. Who May Beneficiary Sue?
An intended beneficiary can sue the promisor if the promisor fails to perform. The
promisor may assert most defenses that would be available against the promisee.
Creditor beneficiaries can also sue the promisee for failure to fulfill the original
obligation of the promisee. Donee beneficiaries generally cannot sue the promisee.
The promisee has done nothing more than attempt to make a gift and attempted gifts
are unenforceable.
C. Assignment of Rights and Delegation of Duties
Parties to a contract can also involve third parties by assigning and delegating.
IIBI
Rs-28
1. The Action - Assignment vs. Delegation
Technically, if a party wants to give contract rights to a third party, it is called an
assignment of rights. If a party wants to have a third party perform contractual duties, it
is called a delegation of duties.
a. Assignment of All Rights
An "assignment of all rights under a contract" is usually interpreted as an
assignment of a contract, which is(both)an assignment of rights and a delegation
of duties.
PASS KEY
The examiners rarely use technical assignments language, but you must know these terms to
learn the different rules relevant to assignment and delegation.
b. The Parties
The person giving the rights to the third party is the assignor. The person
receiving the right is the assignee.
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b.
a.
2. What May be Assigned or Delegated?
Thelgeneral rulelis that any contract right may be assigned and any contract duty may
be delegated.
Cannot Assign or Delegate if it Changes the Basic Obligation ~ l\\sl,\VeI\\\Ce
The{exceptions)are when the assignment will change the obligor's risk or the
delegated duty involves specialized personal services or otherwise relies heavily
on the personal attributes of the person performing (e.g., a duty to perform an
audit is not assignable because the client is relying heavily on the abilities of the
CPA who was hired, but a duty of a new car dealer to deliver a new car from a
certain manufacturer can be delegated because the performance does not
depend on the identity of the party performing).
Cannot Assign Offers - But Can Assign Option Contracts
Note that while offers generally cannot be assigned (because they are not
contracts), options generally can be assigned because they are contracts.
3. Effect of Delegation - Both Parties Liable
A delegation does not release the original party from the contract. After the delegation,
both the delegator and delegee are liable unless there is a novation. The person to
whom the duty is owed can sue either one in any order, but can only get one recovery.
a. Assumed Mortgages - Both Parties Liable I_I
Treat an assumed mortgage as an assignment. When a mortgage is
assumed, both the assignor/mortgagor and the assignee are personally liable.
Upon default the mortgagee (lender) may sue either party.
II
b. Compare Assignee Taking Subject to the Mortgage
If the person takes subject to the mortgage, it is not an assignment.
Upon default the mortgagee can foreclose on the property and hold
the assignor/mortgagor liable. The mortgagee cannot hold the person who took
subject to the mortgage liable.
4. Assignment of a Creditor's Right to Receive Money
a. Permitted Even if Contract Prohibits Assignment
A creditor's right to receive money is assignable to another. This is generally
true even if the contract prohibits assignment.
b. Not Effective against Debtor Unless Debtor Receives Notice
An assignment by a creditor of the right to receive payment is not effective
against the debtor until the debtor receives notice of the assignment. If the
debtor/obligor pays the original creditor/assignor before notice is given, the
debtor does not have to pay the assignee again. However, once notice is given,
payments must be made to the assignee. If the debtor/obligor pays the assignor
instead, (s)he will still owe a duty to pay the assignee.
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EXAMPLE
Alex owes Sue $1,000 under a contract requiring Alex to pay on June 1. On May 2, Sue assigns to Bank
the right to receive the payment. After Alex paid Sue $1,000 on June 1, Bank notifies Alex of the
assignment. Bank cannot collect the $1,000 from Alex. Bank must recover from Sue.
Note: Even though an assignment is not effective against the debtor until notice of the assignment is
received, this does not mean that an assignment without notice is invalid. It merely is not enforceable
until notice is given.
5. Implied Warranties of(Assignor) ~ Collectible AIR
An assignor impliedly warrants that (s)he has the rights assigned and that (s)he will not
do anything to interiere with those rights. (S)he also warrants that (s)he has no
knowledge of any fact impairing the value of the assignment. An assignor who
breaches these warranties is liable for damages.
6. No Formalities Needed
Generally, an assignment need not be made in writing and need not be supported by
consideration. Notice must be given to the third party.
7. Defenses
The obligor may usually assert against the assignee any defenses related to the
contract that the obligor had against the assignor. For example, if the assignor
breached a duty owed to the obligor, the obligor can raise that breach if the assignee
sues the obligor for failure to periorm. Of course, in such a situation, the obligor may
still recover from the assignor unless the assignment was gratuitous.
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SALES
I. INTRODUCTION
The Sales Article of the UCC (Article 2) applies only to sale of goods. You already know a
substantial part of Sales because it generally follows common law contracts. This outline will
highlight the differences between the two. If an issue is not covered. you may assume that the
Sales Article follows the contract rule.
A. Goods - Moveable Personal Property pY'lCe 11.11
The UCC Sales Article applies to the sale of goods, which is defined as all things moveable.
This includes most tangible personal property (e.g., cars, cows, and groceries). The following
are excluded from the Sales Article and are covered by common law contracts.
1. Contracts for personal services and real estate;
2. Contracts for intangible personal property, such as stock or patent rights;
3. Contracts for fixtures-things attached to the land. 1
t--\L\st obsevve COtMtMeVClel\ stel\,,-AeI\vAs
B. Merchants Goods of the Kind Sold <GR _ Stel\"-AeI\vA IIMMMIINI
A number of UCC rules depend on whether one or more of the parties are merchants. You
must be careful to note the status of the parties. A merchant is one who deals in goods of the
kind sold or who has special knowledge regarding the goods being sold.
The UCC is not limited to merchants. It applies to all contracts for sale of goods.
C. Obligation of Good Faith
The UCC imposes an obligation of good faith on both parties to a sales contract.
II. CREATION OF A(CONTRACT) GR - tMOst Y'evoceI\ble
A. Agreement (Mutual Assent) - Offer and Acceptance el\cceptel\\\Ce
I-I
Under the common law, consideration is needed to make an offer
irrevocable. There is a limited exception to this rule that only arises under the UCC-
merchant's firm offers. Certain offers by merchants are irrevocable without
consideration. To qualify as a offerl
Offer: Merchant's Firm Offer 1.
OpHo\\
[
(i) The seller must be a merchant (regularly deals in goods of the kind sold);
tw\etMOY'lz.e! (ii) The offer must be in writing and signed by the merchant;
(iii) The offer must give assurances it will be kept open for a certain time.
Merchant's firm offers are irrevocable for the time stated, or if no time is stated, for a
reasonable time, but in no event longer than three months.
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PASS KEY
It is important to remember that the firm offer rule applies only to offers for the sale of goods by
merchants and only if the offer is in writing. The examiners often try to fool you. They may say that a
merchant phones a buyer offering to sell goods and promises to keep the offer open. The firm offer
rule does not apply because the offer is oral. They might say that a person writes a friend offering to
sell a car and promises to keep the offer open. The firm offer rule does not apply because the seller is
not a merchant. Finally, they might say that a realtor offers in writing to sell a parcel of land and
promises to keep the offer open. The firm offer rule does not apply because the contract is for land,
not for the sale of goods.
2. Acceptance
The Sales Article modifies the common law of acceptance in numerous ways.
R I ~ E a. Mirror Image Rule Does Not Apply under UCC GooAs
Under common law contracts, the terms of an acceptance must mirror the terms
of the offer or there is no contract-just a counteroffer. This is not so under the
UCC. Under the Sales Article an acceptance will be effective even if it states
new or different terms. Generally, under the UCC the new or different terms will
be ignored unless the contract is between merchants. In a contract between
merchants, the terms of the acceptance control unless the offeror objects or the
changes are material.
PASS KEY
Examiners like to test new or different terms in an acceptance. Remember that under the
common law the acceptance must mirror the offer. Under the Sales Article new or different
terms are ignored unless the contract is between merchants. Between merchants minor
changes can generally be made in the acceptance.
Rs-32
b.
f$ilel\i-eveI\l V\\ilel\i-eveI\l
Promise to Ship or Prompt Shipment - Valid Acceptance
Under the Sales Article, an offer to buy goods for current or prompt shipment can
be accepted by either a promise to ship or by prompt shipment unless the offer
indicates otherwise.
EXAMPLE
Bob sends Steve an order for 400 widgets at $1 per widget. Steve can accept by either
promising to ship the widgets or by promptly shipping the widgets.
(1) Shipment of Nonconforming Goods - Acceptance and Breach GR
If prompt shipment of goods is an acceptance, what happens if the seller
ships goods that do not conform to the contract? Under the UCC, a
shipment of nonconforming goods is both an acceptance and a breach of
contract.
EXAMPLE
Barb orders 100 black widgets from Sam. Sam is out of black widgets and so sends 100
blue widgets. The shipment is both an acceptance and a breach of contract, and so
Barb may sue Sam for damages.
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(2) Exception - Notice of Accommodation I_I
If the seller reasonably notifies the buyer that nonconforming goods are
shipped only as an accommodation to the buyer, the shipment is not an
acceptance. It is a counteroffer.
EXAMPLE
Same facts as above, but Sam sends a note before shipment that the blue widgets are
intended only as an accommodation. Barb may accept or reject the widgets, but Sam
has not breached any contract.
PASS KEY
You must remember that the accommodation shipment rule applies only when
shipment is used as the means of acceptance. The examiners often try to trick you by
stating that a party accepts an order by promising to ship. Then the party discovers he
lacks the goods and ships nonconforming goods as "an accommodation." This is a
breach, not an accommodation.
3. Auctions
The UCC contains special rules regarding auctions, which are rarely tested on the
exam. Just to be safe, the key points to remember are as follows:
a. Generally, the bid is the offer and the fall of the hammer is the acceptance.
b. Unless otherwise stated, all auctions are "with reserve" which means that the
seller does not have to sell unless an adequate bid is made.
c. In an auction "without reserve" the goods must be sold to the highest bidder. The
goods can only be withdrawn if no bid is made within a reasonable time.
B. Consideration vee - GR - qL\eI\\\T-lty O\\ly esse\\T-lel\l i-eV'tM
1. Output and Requirements Contracts - Valid if Reasonable
The general rule under the UCC is that quantity must be stated in a sales contract. An
exception is made for output and requirements contracts. In an output contract a buyer
agrees to buy the entire output of a seller's factory for a stated period of time. In a
requirements contract a seller agrees to supply a buyer with all of her requirements for
a stated period of time. Although the exact quantity is unknown, output and
requirements contracts are enforceable if the actual amounts are reasonable with
respect to normally expected amounts.
2. Modifications Enforceable without Consideration
At common law, a modification of a contract is not enforceable unless consideration is
given. The UCC abandoned this rule. Under the UCC, a modification of a contract for
the sale of goods is enforceable, even without consideration, as long as the modification
is sought in good faith.
EXAMPLE
Rick, a book distributor, offers to sell Steve, a bookstore, 100 books for $1 each. Steve accepts. Rick
subsequently discovers that he will lose money on the deal, and so asks Steve if he would be willing to
pay $1.05 for each book. Steve agrees. The modification is binding.
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PASS KEY
Be careful! This exception applies only in the sale of goods. If the example above were to bind books
(a common law service contract), the modification would not be binding because of the preexisting
duty rule.
3. Payment by Check - Permissible
A sales contract may be paid by check, unless the seller demands cash, in which case
the seller must give buyer a reasonable time to obtain the cash.
C. Defenses
1. Fraud
As at common law, fraud is a defense to a contract under the UCC. The defrauded
party may either sue for damages or seek rescission.

@ (iii)
P (iv)
tw\etMOVlz.e!
2. Statute of Limitations -(4 Years)
The UCC statute of limitations is four years. An action must be brought within four
years of the time the cause of action accrued (from the time the contract was
breached).
Statute of Frauds tw\'fLE@:;
Contracts for the sale of goods for $500 or more must be evidenced by a writing signed
by the party being sued. There are(four exceptions) C L /L .1
L\SrOtM rel\l oveQ\
(i) Contracts for@ecially manufactured goods (i.e., goods not generally suitable for
sale to others, such as bowling shirts with a team name embroidered on them);
(ii) Where a merchant sends another merchant a@jitten confirmation of a contract
that is sufficient to bind the sender, it will also bind the recipient if she does not
object within 10 days (e.g., Randy Retailer calls Wendy Wholesaler and orders
$600 worth of goods, and then sends Wendy a written and signed confirmation of
the order. If Wendy does not object, the confirmation is sufficient to bind Wendy
even though she did not sign it). This is known as the merchant's confirmatory
memo rule;
Contracts that the parties have@imitted in court; and
Contracts that have been@)rformed, to the extent that the performance has been
accepted (e.g., an oral contract for 200 widgets at $5 each can't be enforced, but
if 150 widgets are delivered and accepted, it is enforceable to the extent of the
150 accepted widgets).
Rs-34
PASS KEY
The exceptions to the Statute of Frauds for goods can be remembered with the mnemonic "SWAP"-
Specially manufactured goods, Written merchant's confirmatory memo, Admission in court, and
Performance.
EXAMPLE
Sam and Ben orally agree that Sam will specially manufacture a machine for Ben for $40,000. After
Sam spends $30,000 to build the machine, Ben tells Sam that he no longer needs it. Even though the
contract is oral, Ben is bound because the goods were specially manufactured.
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a. Price Measured as Modified
If a sales contract has been modified, it is the contract as it has been modified
that determines whether a writing is required.
EXAMPLE
Able signs a contract to purchase 600 books from Baker for 90 cents each. Subsequently, Able
in good faith asks that the price be reduced to 80 cents, and Baker agrees. The modification is
effective without a writing because the contract as modified is for only $480.
b. What Writing will Suffice - Quantity Only Essential Terms
Under the common law, the writing must include all essential terms. Under the
UCC, terms may be omitted (e.g., if the memorandum is silent, a sale will be at a
reasonable price and delivery at the seller's place of business). The only terms
that cannot be omitted are the quantity term (unless the contract is an output or
requirement contract) and the signature term.
ANCILLARY MATERIAL (for Independent Review)
4. Impossibility and Impracticality
Under contract law if an event occurs that makes the contract objectively impossible
to perform (i.e., no one could perform), the contract is discharged. The UCC is more
lenient. Under the Sales Article, a contract will be discharged for mere
impracticability. The contract need not be impossible to perform. It need only be
impracticable-extremely more burdensome than anticipated because of the
occurrence of an unforeseen event.
a. Failure of Agreed-upon Method of Transportation - No Defense
If the method of transportation called for in the contract is unavailable or
commercially unreasonable, the seller may use a different means of
transportation and the buyer must accept (e.g., if goods are to be delivered by
UPS and UPS is on strike, then the seller can use Federal Express).
END OF ANCILLARY MATERIAL
~ III. DELIVERY, RISK OF LOSS, AND TITLE
A. Introduction
This section deals with the Code's rules for delivery, risk of loss, and passage of title in sales
contracts. Practically every exam has questions on these topics.
B. Delivery and Risk of Loss
As a general rule, the seller's basic duty is to hold conforming goods for the buyer IIBI
and give the buyer reasonable notice to enable the buyer to take delivery. Many
contracts stray from this rule. The UCC has specific rules for when and where delivery of
goods is to be made. Risk of loss (who will bear the loss if the goods are destroyed)
generally depends on the time delivery is made. Note that if goods are damaged or
destroyed after risk of loss has passed to the buyer, the buyer is not discharged from the
contract; rather (s)he still must pay the contract price.
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1.
, 2.
23.
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For Risk of Loss to Pass, Goods Must be Identified
Title and risk of loss cannot pass until the goods are first identified. Goods are
identified when they are marked, segregated or in some manner identified as goods for
a specific buyer.
As Parties Agree Co"i-vel\ci- i-evlMs
The most important rule to remember is that if the parties designate when and where
delivery will occur or risk of loss will pass, their agreement governs.
Where No Specific Agreement (NCo,,-qel\VVle
V
S
cel\se
el\V'V'leV CeI\ e
The Code divides cases where there is no agreement on delivery or risk of loss into two
broad categories: noncarrier cases and carrier cases.
(i)
(ii)
GR - selley a.
hel\s "0 AlAry
i-o Aellvev
Rs-36
In noncarrier cases the buyer will usually pick up the goods at the seller's place
of business (e.g., buying goods at the grocery store).
In carrier cases the parties contemplate a common carrier will be used to ship the
goods (e.g., shipping goods by UPS).
INoncarrier Cases Rules Depend on Seller's Status ( L
.., 0"-lMevCnel\"r
If there is no common carrier involved, the time of delivery is a reasonable time.
The place of delivery is seller's place of business, if he has one, otherwise, the
seller's home. When risk of loss passes depends on whether the seller is a
merchant.
(1) Nonmerchant Seller - Risk Passes Delivery sel\le
If the seller is not a merchant, risk of loss passes to the buyer upon the
seller's tender of delivery of the goods to the buyer.
EXAMPLE
Steve is not in the business of selling computers, but agrees to sell a computer to his
neighbor, Bill, for $400. Bill gave Steve the $400. When Steve tendered delivery of the
computer, Bill said he'd come back later to pick it up. Before Bill returns, the computer
is destroyed by fire through no fault of Steve's. Steve may keep the $400 because Bill
had the risk of loss when the computer was destroyed.
(2) Merchant Seller - Risk Passes on Actual Delivery
With merchant sellers, risk of loss passes only upon actual delivery to the
buyer (i.e., when the buyer takes physical possession).
EXAMPLE
Same facts as the example in (1), above, but Steve is a computer merchant. Steve must
get a computer for Bill or pay damages because Steve still had the risk of loss when the
computer was destroyed.
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b. 1Carrier Cases1- Either Shipment or Destination Contract
If a common carrier is involved, the contract is either a shipment contract or a
destination contract. \'O"'.OC\c. "01-
(1) IShipment Risk Passes on Delivery to Carrier .':
With shipment contracts risk of loss passes to the buyer when
the goods are delivered to the carrier. I" "lAC\c.
EXAMPLE
Brenda Corp. entered into a shipment contract with Sally Co. to purchase a used
computer from Sally Co. It was understood that Sally Co. would ship the computer to
Brenda Corp.'s main office. Even though Sally Co. must arrange for the shipment,
Brenda Corp. bears the risk of loss during shipment, and if the computer is damaged
while in transit, Brenda Corp. must still pay for the computer.
(2) C.I.F. - Cost, Insurance, and Freight
The term C.I.F. means the contract price includes the cost of the goods,
insurance and freight. Risk of loss is on buyer during shipment.
(2) IDestination Risk Passes at Destination I_I
With destination contracts risk of loss passes to the buyer
when the goods reach the destination and seller tenders delivery.
c. Common Shipping Terms
The following are shipping terms that might appear on the exam.
(1) F.A.S. - Free Along Side
F.A.S. (Free Along Side) is a price term that requires the seller to deliver
the goods along side of a specified vessel. Risk of loss passes to the
buyer when the seller gets the goods along side the vessel.

- blAyeV'
hel\s RoL
(3) F.O.B. - Free on Board
F.O.B. is the delivery term you are most likely to see. It stands for "free on
board" and is always followed by a location. On the exam it is usually
F.O.B. the seller's place of business or F.O.B. the buyer's place of
business. F.O.B. the seller's place is a shipment contract. Seller must get
the goods to the carrier for risk of loss to pass. F.O.B. buyer's place is a
destination contract. Seller must get the goods to the destination and
tender delivery for risk of loss to pass.
EXAMPLE
Ann, an appliance retailer, agreed to purchase 100 radios from Stan, an appliance
wholesaler. The contract provided that the goods were to be shipped to Ann by
common carrier "F.O.B. Stan's loading dock." If the radios are destroyed during
shipment, Ann must still pay because she had the risk of loss. If the contract were
"F.O.B. Ann's store" and the radios were destroyed in transit, Stan would bear the loss.
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Regulation 5
d.
Becker Professional Education I CPA Exam Review
Effect of Breach on Risk of Loss
If the seller sends nonconforming goods (goods that do not meet the contract
description), the risk of loss remains on the seller, regardless of the shipping
terms, unless the buyer accepts the defective goods.
EXAMPLE
Betsy orders 100 alarm clock radios from Stan "F.O.B. Stan's loading dock." Stan sends 100
table radios. If the radios are destroyed in transit or shortly after the goods reach Betsy
(before acceptance). Stan bears the risk of loss despite the "F.O.B. Stan's loading dock" term.
4. Risk in Sale on Approval and Sale or Return Contracts
Under the Code, all sales are final, unless otherwise agreed. The UCC provides for
two types of nonfinal sales: sale on approval and sale or return.
a. Sale on Approval- Risk on Seller Until Approval
In a sale on approval, the sale is not final until the buyer gives his approval (i.e.,
a sale with a trial period). Title and risk of loss remain with the seller until the
buyer approves.
EXAMPLE
Stacy sells a television to Ben. The agreement provides that Ben may return the television
within 30 days if he is not happy with it. During the 3D-day period, Stacy bears the risk of loss
until Ben indicates his acceptance. If the television is destroyed on the fifteenth day, and Ben
has done nothing to accept, Stacy bears the loss.
b. Sale or Return - Risk on Buyer Until Returned
A sale or return is a completed sale on delivery, but the buyer has the right to
return the goods (this is sometimes called a "sale on consignment"). Risk of loss
passes to the buyer when the seller completes her delivery requirements. Risk
remains with the buyer until the goods are completely returned.
EXAMPLE

Rs-38
5.
Dan is a distributor of magazines. Each month, Dan sells 1,000 magazines to Richard, a retailer.
The contract provides that Richard may return whatever magazines are left at the end of the
month to Dan. This is a "sale or return" contract. If any magazines are stolen from Richard's
store, he bears the loss.
BL\yevs
Insurable Interest when Goods are Identified
The Code provides the buyer with an insurable interest in goods as soon as the seller
identifies the goods to the contract (i.e., marks, tags or segregates the goods as goods
for that specific buyer). Of course the seller has an insurable interest as long as he
owns the goods. Both parties can have an insurable interest in the same goods
simultaneously.
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PASS KEY
The most frequently tested Article 2 issue is risk of 1055. The key things to remember are:
Risk of 1055 is not determined by who has title.
Regulation 5
Noncarrier cases: If the seller is not a merchant, risk of 1055 passes to buyer upon seller's tender of delivery. If the seller is
a merchant, risk of 1055 only passes when the buyer gets physical possession.
Common carrier cases: With shipment contracts (i.e., F.G.B. seller's place) risk of 1055 passes when the seller gets the
goods to the carrier. With destination contracts (i.e., F.G.B. buyer's place) risk of 1055 passes when the goods reach the
destination and seller tenders delivery.
If the goods are nonconforming, risk of 1055 is always on the seller regardless of the shipping terms.
C. Title ow\\eV'ship
1.
2.
Title Generally Can Pass as Parties Agree
Title can pass at the time and place the parties agree, but before title can pass, the
goods must be identified to the contract.

If Parties Do Not Agree, Title Passes upon Delivery (1)
e rl\\eI\rlO\\
If there is no agreement as to when title will pass, title passes when seller completes
her delivery requirements. The time of delivery can vary depending on the delivery
term used.
EXAMPLE
Bea agreed to purchase 100 radios from Steve "F.G.B. Steve's warehouse." Title passes to Bea at the
time the radios are given to the carrier, because that is where delivery occurs. If the delivery term
were "F.G.B. Bea's store," title would pass when the radios were delivered to Bea's store.

3. Buyer Rejects Goods - Title Revests with Seller
If the buyer rejects the goods, whether the rejection was rightful or wrongful, title
revests in the seller. (Recall that if nonconforming goods are shipped, risk of loss
remains with the seller despite the buyer's title.)
WARRANTIES<
ItMpheA I'HUb.1
A. In General lel\w - SL\bsi-eI\\\T-lel\l
In sales a seller must make a "perfect tender" (i.e., the seller's delivery must be perfect
without any defects). To fulfill the requirement of perfect tender, the goods must conform to
all warranties. There are four warranties that you must know:
(i) Express warranties; OV'eI\l OV' wV'ii-i-e\\ - "CO\\i-vel\ci- i-eV'tMS"
ItMplieA i-hL\S, [(ii) The implied warranty of title;
\\oi- OV'eI\l OV' (iii) The implied warranty of merchantability; and
wV'ii-i-e\\ (iv) The implied warranty of fitness for a particular purpose.
In reviewing the material on warranties, it is important to note: how the warranty is made, who
makes the warranty, and how the warranty can be disclaimed.
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B. Express Warranties OV'eI\l OV' wV''iH-e\\
1. Statements of Fact, Descriptions or Samples or Model tw\eI\Ae by selleV' to 'i\\AL\ce
An express warranty will arise from any statement of fact or promise made by the pL\V'chel\se
seller, any description of the goods made by the seller, or any sample or model shown
by the seller. The express warranty is that the goods will conform to the statement of
fact, to the description or to the sample or model.
2. Creation - Must be Part of the Basis of the Bargain
An express warranty can be made by any seller and may be oral or written.
Statements of value or opinions do not generally create an express warranty. The
statement must involve facts. Additionally, the UCC requires that the express warranty
be a part ofthe basis of the bargain (i.e., played some part in the buyer's decision to
buy).
EXAMPLE
Astatement that a car is a "1997 Ford and a beauty" creates a warranty that the car is a 1997 Ford,
since this a fact. It does not create the warranty that the car is a "beauty," since this is an opinion, not
a fact.
PASS KEY
When examiners test express warranties, they frequently ask about the requirement that the express
warranty be a part of the basis of the bargain. Look for this in express warranty questions.
1""""';;'1 3.
ItMplleA
#\ c.

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3. Can be Made by Any Seller
Any seller can make an express warranty; it is not limited to merchants.
4. Very Difficult to Disclaim
Under the Sales Article, express warranties are very difficult to disclaim.
Implied Warranty o ~
1. Good Title, No Unstated Encumbrances, and No Infringements
Implied in every sales contract is the warranty that the seller has good title and the right
to transfer that title. The seller also impliedly warrants that there are no unstated
encumbrances (i.e., no unstated liens or attachments on the goods). If the seller is a
merchant, he also impliedly promises that the goods do not infringe on any patent or
trademarks.
2. Title and Encumbrances Made by Any Seller
The warranty of title and the warranty against encumbrances are made automatically
by every seller unless disclaimed. Only merchant sellers automatically make the
warranty against infringements.
May be Disclaimed Specifically or by Circumstance Not el\S 'is
The implied warranty of title can only be disclaimed by specific language or by
circumstances that indicate the seller is not guaranteeing he has title (e.g., judicial
sale). A general disclaimer cannot disclaim title (e.g., "merchandise is sold as is,"
"with all faults," "seller makes no warranties beyond the face of this instrument," or "I
disclaim any and all warranties").
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PASS KEY
The examiners love the warranty of title. The key point to remember is that it cannot be disclaimed by a
general disclaimer such as "as is" or "with all faults." It can be disclaimed only specifically (e.g., "I do not
warrant title") or by circumstance (e.g., judicial sale).
1"1
#2 D. Implied Warranty of(Merchantability}
1. Merchants Promise Goods Fit for Ordinary Purposes
In every sale by a merchant who deals in goods of the kind being sold, there is an
implied warranty that the goods are fit for ordinary purposes. The warranty is implied-
no writing or oral promise is required.
Note,
Made Only by Merchants
The implied warranty of merchantability is made only in sales by merchants.
however, that the buyer need not be a merchant.
Disclaimed by "As is" Sale or by Stating No Merchantability
Merchantability can be disclaimed by a statement that the goods are sold "as is" or
"with all faults." Absent a general disclaimer, like "as is," merchantability can only be
disclaimed by using the word "merchantability." The disclaimer may be oral. If the
disclaimer is in writing, the disclaimer must be conspicuous. A purported disclaimer
stating "we hereby disclaim any and all warranties" is ineffective.t)lSclel\ltMS
Implied Warranty of Fitness for Particular Purpose "ol-l'I,,,,,1III.' ..... :: 1
1. Made When Seller Selects Suitable Goods for Buyer
The implied warranty of fitness for particular purpose arises when the
(buyer relies)on any seller (does not need to be a merchant) to select goods suitable for
the buyer's particular purpose. The{seller must know)of the particular purpose and that
the buyer is relying on him to select the goods.
o\\ly \NeI\V'V'eI\\\ty 2.
thel\t V'eqL\lV'eS
tMeV'chel\\\t seneV'
3.
2. Compare to Merchantability
Merchantability requires the goods to be fit for ordinary purposes. Fitness requires the
goods to be fit for the buyer's exact purpose. Fitness can be made by any seller. It is
not limited to merchants.
EXAMPLE
Ben goes to "Sam the used car man" and tells Sam that he wants to buy a car suitable for towing his
two-ton boat. Sam selects a Chevy Blazer for Ben. There is an implied warranty of merchantability
that the Blazer will be fit for ordinary purposes, such as driving around town, and an implied warranty
of fitness for particular purpose that the Blazer can tow a two-ton boat.
3. Disclaiming Fitness for Particular Purpose
Fitness, like merchantability, can be disclaimed by selling the goods "as is" or "with all
faults." If not disclaimed by an "as is" sale, fitness must be disclaimed by a
conspicuous disclaimer. The writing need not mention fitness (e.g., "I make no
warranties beyond the face of this contract" is sufficient).
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PASS KEY
Examiners often test on implied warranties. The following are the key things to remember:
Any implied warranty can be disclaimed, if the correct words are used (even by merchants).
Implied warranties arise without a writing. They are automatically implied in a sales contract.
Differences between merchantability and fitness: The warranty of merchantability can only be made by
merchants and is a warranty only that the goods will be fit for ordinary purposes. The warranty of fitness
can be made by any seller, but only if the buyer is relying on the seller to pick goods suitable for a
particular purpose and is a warranty that they will be fit for that purpose.
Warranties are independent from tort liability (negligence or strict liability) as discussed below.
ANCILLARY MATERIAL (for Independent Review)
F. Warranty Protection Not Limited by Privity
At common law, generally only a party to a contract could sue for damages. The Sales Article
is more lenient. Under the UCC, warranty liability is not limited by privity. It extends to those
who are members of the buyer's household. It also extends to those expected to use,
consume or be affected by the product (e.g., a visiting uncle who borrows a defective electric
razor and is injured could sue).
WARRANTIES
Type How Arise By Whom Disclaimer
Express By affirmation of fact, Any seller Cannot disclaim
promise, description, model
or sample
Implied
Warra nty of Title (title is good, transfer By sale of goods Any seller By specific language or
rightful, no liens or encumbrances) circumstances showing
seller does not claim title
Warranty of Merchantability (fit for By sale of goods of the kind Merchant only By disclaimer mentioning
ordinary purposes) regu larly sold by the "merchantability" (if written
merchant disclaimer, it must be
conspicuous)-
Warranty of Fitness for Particular By sale of goods where Any seller By conspicuous written
Purpose (fit for buyer's particular purpose) seller has reason to know of disclaimer-
particular purpose and of
buyer's reliance on seller to
choose suitable goods
- These may also be disclaimed by language such as "as is"; by inspection (or refusal to inspect); or by course of dealing, course of
performance, or usage of trade.
END OF ANCILLARY MATERIAL
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el\ci- 1\\i-e\\T-lo\\eI\l -
G. Tort Liability <\.1 L
..,eq lqe\\r
The examiners have a number of questions about the tort liability of sellers of defective
products under either a negligence theory or strict products liability theory.
1-4''';1
1. Negligence-Failure to Use Reasonable Care
Those injured by goods can sue negligent sellers. They must prove:
a. Seller owed them a duty of care;
b. Seller breached the duty by failing to use due care (e.g., selling unsafe goods);
c. Damages-the plaintiff suffered damages; and
d. Causation-the damages were caused by the seller's negligence.
2. Strict Products Liability I_I
Those injured by goods can sue in tort for strict products liability. The focus is
on the product and not on the seller's conduct. They must prove:
The product reached the user without substantial change in condition.
(i)
(ii)
(iii)
(iv)
(v)
a.
b.
The product was defective when it left the seller's hands;
The defect caused the plaintiff's injury;
The defect made the product unreasonably dangerous;
The seller was in the business of selling this type of goods; and tw\evchel\\\i-/
Aeel\lev
Privity Not Required
Strict products liability is not a contract action. It is a tort action. Thus, privity of
contract is not required. Plaintiff need not be a buyer or user (e.g., plaintiff could
be a bystander).
Negligence Not Necessary
Strict products liability in tort is liability without fault. The plaintiff does not need
to prove negligence. Thus, it is not a defense that the defendant was not at fault
or that the defendant followed industry custom.
PASS KEY
Strict products liability is frequently tested. The following are the key areas to remember:
Know the elements (defective product, caused injury, unreasonably dangerous, seller in the
business of selling these goods and no substantial changes).
Privity is not required. Plaintiff need not have bought and seller need not have sold to the injured
party.
Negligence (failure to use reasonable care) is not required. Sellers are strictly liable.
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V. REMEDIES
A. Introduction
The Sales Article provides for numerous remedies to the seller and the buyer. These
remedies are detailed below.
2.
B.
1....1
-
I-I
Remedies of Buyer or Seller
1. Anticipatory Repudiation - Sue or Wait ~ e e p e l \ ~ e 24
Anticipatory repudiation occurs when either the buyer or seller indicates in advance of
performance that he will not perform. The nonbreaching party may sue immediately,
cancel the contract, demand assurances (see below) or wait until the time for
performance and sue then if the other party fails to perform. The repudiating party has
the right to withdraw the repudiation until the other party relies (e.g., by bringing suit).
Right to Demand Assurances if Reasonable Grounds Exist
Under the UCC Sales Article, if one party has reasonable grounds to believe the other
party will not perform when required, she may make a written demand for an assurance
of performance from the other. Failure to give this assurance within a reasonable time
is an anticipatory repudiation.
3. Punitive Damages - Not Available in Sales FVeI\lA.::A O\\ly - \\oi- bveel\ch
Punitive damages are not available under the Sales Article.
4. Duty to Mitigate - Avoid Damages
Both buyer and seller have a duty to mitigate damages. They cannot recover for
damages that could have been avoided.
C. Seller's Remedies BlAyev bveel\ches
1. Seller's Right to Cancel and Sue for Damages
If the buyer breaches the contract, the seller can cancel or rescind and/or sue for
damages.
2. Seller's Right to Withhold Delivery and Stop Goods in Transit
The seller may withhold delivery if the buyer has failed to make a required payment or
has repudiated the contract. The seller may also stop delivery of goods in transit for
the same breaches.
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3.
a. Stop Goods in Transit for Buyer's Insolvency
If a seller discovers a buyer is insolvent, the seller may stop any delivery and
demand cash. The buyer has a right to the goods if she tenders cash.
b. Reclaim Delivered Goods for Buyer's Insolvency
If an insolvent buyer has already received the goods, the seller may reclaim them
within 10 days after receipt. This 10 day limitation does not apply if the buyer
made a written misrepresentation of solvency.
Seller's Right to Resell and Sue for Damages
If the buyer breaches, the seller has the right to resell the goods. The seller may also
sue the buyer for any losses the seller may have. This is usually the difference
between the contract price and the resale price plus any additional or incidental
damages (e.g., storage fees and the cost of resale).
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. ..

to -:.
4. Seller's Right to Full Contract Price
The seller can collect the full contract price plus incidental damages if the goods cannot
be resold for any price (often the case when the goods are specially manufactured) or if
the goods are destroyed after risk of loss has passed to the buyer.
Liquidated Damages - Must Be Reasonable
A liquidated damages clause in a sales contract is valid if the amount is
reasonable with respect to the harm done and is not a penalty. Even if there is no
liquidated damage clause, if the buyer has made a down payment and breaches, the
seller may keep the lesser of $500 or 20% of the price.
Buyer's Remedies bY'eel\ches
1. Buyer's Right to Reject for Any Nonconformity
Under the UCC, the seller must make al"perfect tender'+-a delivery free from any
defects. If the goods do not conform to the contract, the buyer may reject all of the
goods, reject some of the goods, or reject none of the goods. The buyer may also sue
for damages.
5.
D.
a. Formal Requirements for Rejection
Rejection must be made within a reasonable time. To be effective the buyer
must notify the seller and state reasons for rejection. Between merchants, the
buyer must follow reasonable instructions of the seller.
b. Seller's Right to(Cure) Fhc the pY'obletM 1'%;1
After the buyer rejects, the seller has a right to cure the defect if there is any time
remaining under the contract for the seller's performance. The seller need only
notify buyer the defect will be timely corrected.
c. Right to Inspect Before Payment
The buyer usually has the right to inspect goods prior to payment. However, the
buyer may not inspect prior to payment in a C.O.D. (cash on delivery) sale.
d. Revocation of Acceptance for Substantial Defects
The buyer has the right to revoke an acceptance for substantial defects that a
reasonable inspection would not show.
2. Buyer's Right to(Cancel)or Rescind FoY' eI\\\Y
If the goods are nonconforming, the buyer can cancel the contract and sue for
damages.
3. Buyer's Right to Sue for Damages
a. For Accepted Nonconforming Goods (Breach of Warranty)
The buyer may accept nonconforming goods and sue for damages. Damages
are usually the difference between the value of conforming goods and the value
of the goods as delivered plus incidental and consequential damages.
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Regulation 5
b.
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For Rejected or Undelivered Goods
If the goods are undelivered or buyer rightfully rejects, the buyer may:
(i) Cover (i.e., the buyer can purchase comparable goods (cover) and sue the
seller for the difference between the contract price and the cost of cover).
I-I
114W;';1
4.
(ii) Sue for the difference between the market price and the contract price plus
any incidental and consequential damages.
Buyer's Right to Specific Performance or Replevin
Specific performance may be used in a sales contract if the goods an{unigue)or if the
buyer cannot reasonably cover. (Replevin)(the right to recover goods wrongfully in the
hands of the seller) may be used if the goods are identified and the buyer cannot
reasonably cover.
EXAMPLE
Bob, an engine assembler, contracts with Steve, a parts manufacturer, for 1,000 engine parts to be
picked up by Bob on June 1. Steve has several similar contracts with other engine assemblers. By June
1, Steve has completed a run of 2,000 parts of the type Bob wants, but Steve has not identified any as
the ones for Bob. When Bob arrives, Steve refuses to deliver any parts to Bob. If Bob cannot get
replacement goods in time, he has a right to specific performance. If the goods had been identified to
the contract, Bob could have replevied them.
5. Buyer's Rights on Seller's Insolvency
If the buyer has paid part or all of the price and seller is insolvent, the buyer may
recover the goods from the seller if the goods are identified.
VI. ENTRUSTING AND VOIDABLE TITLE GR - TvL\e ow"ev Cel\" vecovev si-ole"
The general rule is that a seller cannot transfer any better title than the seller has. Thus, a thief, "3vA
who has no title, generally has no power to transfer good title to stolen goods. However, the Sales peI\vi-ies
Article provides two exceptions to this general rule where a seller can transfer better title than the
seller has.
A.
B.
Rs-46
Entrusting
If the owner of goods entrusts them to a merchant who deals in goods of the kind sold, and
the merchant sells them in the ordinary course of business to a bona fide purchaser for value,
the purchaser gets good title even though the merchant did not have good title. But be
careful! This rule applies only if the goods were entrusted to a merchant (not, for example a
bank), and the goods were sold in the ordinary course of business (not at a bulk sale of the
merchant's business).
Voidable Title lvic\c.eA - bel\A chec\c.
If the owner of goods is defrauded into giving a thief title, the owner ordinarily can rescind the
contract and recover the goods from the defrauder (i.e., the thiefs title is voidable). However,
if the defrauder has since sold the goods to a bona fide purchaser for value, the purchaser
gets good title. The defrauded former owner can no longer recover the goods. A suit against
the defrauder for damages is the only remedy.
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AN elL LA RY MAT ER I A L (for Independent Review)
Regulation 5
EMPLOYER-EMPLOYEE LAW
I. FEDERAL INSURANCE CONTRIBUTION ACT (FICA) IUdl
A. Purpose
The Federal Insurance Contribution Act (FICA) provides workers and their dependents with
benefits in case of death, disability, or retirement. Medicare covers hospital insurance.
B. Who Must Participate?
All full-time and part-time employees must participate in the program. The self-employed
must also participate if their net profit exceeds $400 in a year. Very few workers are exempt
(e.g., certain government workers and ministers).
C. Who Pays for the Program?
FICA is funded by taxing income earned from labor (e.g., wages, salaries, tips, bonuses,
commissions, etc.). FICA is funded by both employers and employees, including those self-
employed persons.
1. Employers - Must Match Employee's Contribution
a. Employers must match their employees' contributions to FICA
b. Employers are responsible for paying the tax and withholding the employee's
contribution. An employer that fails to withhold the employee's contribution is
liable to pay the employee's half, but has a right to reimbursement from the
employee. If an employer voluntarily pays the employee's share, it is deductible
for the employer and taxable income for the employee.
c. Penalties apply to employers who fail to make timely FICA deposits or who fail to
supply their federal taxpayer identification number.
2. Employees - Taxed Only on Earned Income
a. For 2010, employees were liable to make FICA contributions of 6.2% of their
gross wages of up to $106,800 and Medicare contributions of 1.45% of their
entire gross wages.
b. Gross wages includes all earned income, such as salary, bonuses, and
commissions. Gifts, interest, dividends, etc. are not wages.
3. Self-Employed Persons - Taxed Only on Net Income
Self-employed persons pay into FICA through the self-employment tax, that is equal to
the employer's and the employee's contribution (15.3%). It is imposed only on net
profits and only if the net profits exceed $400 in a year.
PASS KEY
The examiners often ask what income is subject to FICA. It is key to remember that an employee's gross
wages are subject while a self-employed person's net profits are subject.
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D. Deductibility - by Employer, Not Employee
1. The employer's contribution is deductible as an ordinary business expense.
2. The employee's contribution is not deductible by the employee.
3. Since a self-employed person pays both contributions, one-half of the self-employment
tax is deductible in arriving at adjusted gross income.
E. Benefits - Can Receive More than was Contributed
1. FICA provides a number of benefits, including disability pay, retirement pay, survivor's
benefits, dependent's benefits, and medical benefits under Medicare (not Medicaid,
which is a state-run program).
2. Benefits are available to all covered employees regardless of whether they are
receiving benefits from a private plan. Employees may not opt-out of social security,
even if they are covered by a private plan.
Note: It is not only the qualifying employee who receives benefits, but his family as well.
Thus, persons can receive benefits even though they have made no payments into
social security.
F. Taxability
1. Social security disability and health benefits are not taxable income.
2. Under the Senior Citizen's Freedom to Work Act, retirement benefits of persons 65 and
under can be reduced if the person goes back to work. (There is no reduction for
income other than income earned from labor.)
3. Social Security retirement benefits are taxable income to a recipient only if his or her
annual income is greater than $25,000 ($32,000 for joint filers).
------------------------------------
PASS KEY
The most important things to remember about social security for exam purposes are:
The employer must pay the tax and collect an employee's portion of the tax.
All income derived from labor is taxed; unearned income is not taxed.
All employees are subject to the tax up to a maximum dollar amount for the social security with no limit
on the Medicare; self-employment income is subject to both employer and employee taxation for income
over $400.
II. UNEMPLOYMENT COMPENSATION (FUTA)
A. Purpose - Provide Unemployment Insurance
liiiihi 1. The Federal Unemployment Tax Act (FUTA) establishes a state run system of
insurance to provide income to workers who have lost their jobs.
2. Although FUTA provides federal guidelines, the states actually administer the program,
set standards, and determine payments.
B. Who Must Participate in the Federal Unemployment Plan?
1. All employers who have quarterly payrolls of at least $1,500 or who employ at least one
person for 20 weeks in a year must participate in the system.
Rs-48
2. Unlike FICA, self-employed persons do not participate.
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PASS KEY
Regulation 5
Since most employers must participate under FUTA, the examiners often try to trick you into thinking that
every employer must participate. This is not true. The $1,500 minimum or time requirements must be met.
c. Who Pays for the Program?
1. Unemployment taxes are payroll taxes generally assessed only against the employer.
The federal unemployment tax rate currently is 6.2% on the first $7,000 per year of
compensation for each employee.
2. Employers can get a credit of up to about 87% (5.4%) of the federal tax due for
payments made on account of state unemployment taxes. Moreover, the state rate can
be reduced if the employer has a below-average rate of unemployment claims from
prior employees.
D. Deductibility - by Employer, Not Employee
1. The employer's payment is deductible as an ordinary business expense.
2. Since the employee generally does not pay the tax, it is not deductible by the
employee.
PASS KEY
When the examiners test on unemployment issues, they often test on the concept above. It is key to
remember that the employer may deduct the tax (since the employer pays it), but the employee may
not take a deduction.
E. Benefits
1. Unemployment benefits are generally available only when an employee loses his or her
job or is not working through no fault of his or her own.
2. Benefits are distributed to employees by the state governments. The amount paid
varies from state to state, but is usually determined by how long the employee has
worked and his or her former rate of pay.
3. Note that payments are not limited to the amount that has been paid by the employer
on the employee's behalf.
PASS KEY
The most important things to remember about FUTA for exam purposes are:
The employer must pay if he employs an employee for at least 20 weeks in a year or paid $1,500 in
wages in a quarter. The employee does not pay.
Because the employer pays, the tax is deductible as a business expense. The employee cannot
deduct.
If an employer's claim rate is low, he may get a deduction for state unemployment tax.
The employee's benefits are not limited to the contributions made on his behalf.
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III. WORKER'S COMPENSATION
A. Purpose
Worker's compensation programs are state-run programs designed to enable employees to
recover for injuries incurred while on the job.
1.
1=-=-1
Basis for Recovery is Strict Liability
a. Employers are strictly liable regardless of fault. The only requirement is that the
injury occurred while acting in the scope of employment.
b. The employee's negligence or assumption of the risk will not bar recovery.
Employees may recover even if grossly negligent.
c. Fighting, intoxication and self-inflicted wounds will bar recovery.
PASS KEY
Fault is the most frequently tested issue in workers' compensation. Remember that an employee can collect
whether he was negligent, grossly negligent, or assumed the risk. An employee cannot recover for injuries
resulting from intoxication, fighting or self-inflicted wounds. Remember, the purpose of workers'
compensation is to enable employees to recover for work-related injuries regardless of negligence.
2. Action Against Employer Limited to Worker's Compensation Recovery
a. Workers generally may not sue their employers. Their recovery is limited to
whatever worker's compensation benefits are available.
b. Workers may sue employers if the employer intentionally injured them.
c. Although workers generally cannot sue the employer, they can sue third parties
and receive worker's compensation benefits. If successful in their suit, the
insurance carrier is entitled to reimbursement for any duplication of worker's
compensation benefits paid.
B. Who Must Participate?
1. Most employers must participate in worker's compensation programs.
2. There are exceptions for agricultural workers, domestic workers, casual workers (e.g.,
temporary office workers), public employees, and independent contractors. Some
states also exempt employers who have up to only three or four employees.
C. Who Pays for the Program?
1. The employer pays for worker's compensation by purchasing insurance from the state
or a private carrier. Some states also allow employers to be self-insuring if they can
prove they are financially responsible.
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2.
3.
In most states, coverage is compulsory.
In states where coverage is not mandatory, an employer who elects not to participate in
worker's compensation gives up the common law defenses of contributory negligence,
assumption of the risk, and the fellow servant doctrine. Damages are not limited to
what would be recovered under worker's compensation.
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D. Benefits
Worker's compensation provides benefits for any injury or disease (including aggravations of
existing diseases) resulting from employment. Benefits include money for loss of income,
disability, loss of limbs, prosthetic devices, medical services, burial costs, and survivor's
benefits. The program works like other insurance-benefits are not limited to what was paid
in on the employee's behalf.
E. Deductibility
1. Worker's compensation insurance premiums are ordinary business expenses
deductible by the employer.
2. Because employees do not pay, there is no deduction for the worker.
I'gU;I..l1.6". I
IV. EMPLOYMENT DISCRIMINATION
A. Title VII
Title VII of the Civil Rights Act of 1964 prohibits discrimination in employment on the basis of
race, sex, religion, color or national origin. The Act is enforced by the Equal Employment
Opportunity Commission (EEOC) and applies to all employers having 15 or more employees.
1. Defenses
a. Complaints under Title VII are heard by the EEOC and not the courts.
b. There are three basic defenses. Unequal treatment can be due to (i) a bona fide
seniority system, (ii) merit, including professionally developed ability tests, or (iii)
a bona fide occupational qualification (i.e., a qualification, skill, or attribute
reasonably necessary for a business).
c. An employee can always be terminated for cause.
2. Remedies
The employee may obtain an injunction prohibiting further discrimination and may
recover up to two years' back pay for Title VII violations.
3. Sexual Harassment

The Supreme Court has held that sexual harassment can violate Title VII as a form of
discrimination based on gender.
Equal Pay Act B.
1. The Equal Pay Act prohibits an employer from discriminating on the basis of sex by
paying unequal wages on the basis of sex.
2. The courts will compare persons in substantially similar jobs to determine whether
there is discrimination.
3. If an employer is paying unequal wages for similar work, the employer will be liable for
back pay unless the unequal pay is the result of a sex-neutral factor, such as seniority
or quantity or quality of work.
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C. Age Discrimination
The Age Discrimination Act prohibits discrimination in the hiring, firing, or compensating of
workers on the basis of age. The Act protects workers age 40 and over and applies to
employers having 20 or more workers.
1.
-
Generally Prohibits Mandatory Retirement Age
The Age Discrimination Act generally prohibits mandatory retirement at any age unless
one of the defenses set out below is available.
2. Defenses
Defenses include a bona fide occupational qualification or seniority system.
Remember that an employer can always terminate for cause. It is not a defense that
the discrimination was unintentional. Both intentional and unintentional age
discrimination are prohibited.
3. Remedies
A person who proves age discrimination is entitled to sue in court for an injunction
against further discrimination and back pay. They do not receive early retirement.
D. Americans with Disabilities Act
1.

The Americans with Disabilities Act (ADA) prohibits employers with 15 or more
employees from discriminating against individuals on the basis of physical or mental
disability.
2. It also gives all individuals access to buildings open to the public, mass transportation,
telecommunications services, and government services.
3. It generally requires employers not to discriminate against qualified job applicants and
employees who have disabilities or who become disabled.
4. Employers need to make reasonable accommodations for the needs of disabled
employees and customers.
v. OCCUPATIONAL SAFETY AND HEALTH ACT (OSHA)
A. Who Must Comply?
OSHA applies to all businesses affecting interstate commerce.
B. Enforcement
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1.
2.
3.
4.
OSHA may set safety standards for worksites and may conduct worksite inspections,
examine employers' records, and question employees without advance notice and
without a search warrant.
Employees have a right to request OSHA inspections, and both employees and
employers have a right to accompany investigators during inspections. Employers
cannot retaliate against employees for reporting violations.
An employer may be cited and fined for violations. OSHA's decision may be appealed
to the federal appellate court.
If an OSHA inspector thinks a worksite poses an imminent danger, either OSHA or
employees may seek corrective orders in the federal district court.
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C. Penalties
1. OSHA provides for fines of up to $1,000 per day and civil penalties of up to $10,000 per
willful or repeated violation.
2. For violations resulting in death, employers can be fined $10,000 and jailed for up to six
months.
D. Recordkeeping and Reporting
1. Employers with 11 or more employees must keep a log for five years that records
employees' job-related injuries and illnesses.
2. Employers must file annual reports on injuries and illnesses.
VI. FAIR LABOR STANDARDS ACT
A. In General
1. The Act establishes a minimum wage ($7.25 per hour). As long as covered employees
are making at least the minimum wage, the basis of pay may be hourly, weekly,
monthly, by piece rate, etc.
2. The Act sets an overtime rate (currently 1.5 times the hourly rate) for workweeks of
more than 40 hours. Note that FLSA does not require 1.5 times the hourly rate for work
over 8 hours a day or for weekends.
3. The Act contains equal pay provisions and restrictions on child labor.
B. Child Labor Restrictions
1. The Act regulates the employment of children outside of agriculture.
2. It prohibits employment of anyone under the age of 14, except as newspaper deliverers
or child actors.
3. It also limits the hours 14 and 15 year olds can work (both the number of hours and the
times-so as not to interfere with school).
4. It prohibits persons under 18 from being employed in hazardous work.
C. Exclusions
The FLSA contains a number of exclusions. For example:
1. Newspaper deliverers are exempt from minimum wage, overtime pay, equal pay, and
the child labor provisions.
2. Cab drivers are exempt from overtime provisions, but not minimum wage.
3. White-collar employees (e.g., executives, administrators, professionals, outside sales
employees, certain computer employees and highly compensated employees) earning
at least $455 per week are exempt from both minimum wage and overtime provisions,
subject to the following rules:
a. To qualify as an executive, the employee must direct the work of at least two full-
time employees and have weighty input on decisions to hire and fire employees.
b. To qualify as an administrator, the employee's work must be non-manual work
directly related to management.
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Regulation 5
c.
d.
e.
Becker Professional Education I CPA Exam Review
To qualify as a professional, the employee must be (i) performing intellectual
work in a field of science or learning or (ii) performing work requiring invention,
imagination, originality, or talent in a recognized artistic field.
To qualify as a computer professional, the employee must be employed as a
system analyst, computer programmer, software engineer, etc. who either
consults with users or designs, develops, or documents computer systems or
programs (an employee will be considered a computer professional if he earns
either a salary of $455 per week or $27.63 per hour).
To qualify for the outside sales exemption, the employee must be customarily
involved in the sale of goods or services away from the employer's place of
business.
f.
1.
To qualify for the highly compensated employee exemption, the employee must
earn at least $100,000 a year and perform at least one of the functions of the
persons qualifying for the previous exemptions.
4. Note: Non-management, blue-collar workers (e.g., plumbers, carpenters, electricians,
laborers, etc.), police officers, fire fighters, paramedics, and other first responders do
not fall within the exemption regardless of how much money they earn.
VII. NATIONAL LABOR RELATIONS ACT (NLRA)
A. Introduction
The National Labor Relations Act (NLRA or Wagner Act) originally was adopted to give
workers the right to bargain collectively for wages and other terms of employment (e.g.,
sick pay and vacation pay).
2. To "bargain collectively" means that the parties must meet at reasonable times and
confer in good faith with respect to wages, hours, and other conditions of employment.
B. Prohibitions
The NLRA prohibits employers from:
1. Interfering with employee attempts to unionize and bargain collectively;
2. Discriminating against persons on the basis of labor union membership (except that
labor contracts can require employees to join the unions);
3. Discriminating against an employee for filing charges or testifying about the employer's
violations of the Act; and
4. Refusing to bargain collectively with the employees.
C. Labor Management Relations Act (LMRA or Taft-Hartley Act)
Under the LMRA, labor unions are prohibited from charging excessive union fees, forcing
employers to pay for unperformed services, or calling an improper strike.
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VIII. PENSIONS AND RETIREMENT PLANS - ERISA
A. Introduction
The Employee Retirement Income Security Act (ERISA) governs federal pension laws. The
Act does not require employers to have retirement plans or require contributions to existing
plans. Rather, if an employer does have a pension plan, ERISA seeks to protect retirement
plan participants by establishing rules for management and participation in the retirement
plans.
B. General Rules
I.AI
1.
2.
3.
ERISA establishes standards for the funding and investing of pension plans. These
financial controls are to avoid mismanagement. For example, ERISA imposes fiduciary
duties on pension fund managers and prohibits employers from unduly delaying an
employee's participation. ERISA does not require that employees be included as
pension-plan managers.
ERISA requires that employees and beneficiaries receive basic information regarding
the plan (e.g., receive a summary of the pension plan and an annual report).
ERISA establishes requirements for vesting. An employee's right to her own
contributions vest immediately. An employee's right to employer's contributions only
vest after a specified number of years of employment.
C. Eligibility Rules
1. Not all employees need be eligible to participate in pension plans under ERISA (e.g.,
persons under 21 may be excluded).
2. Employees may be required to complete a certain period of eligibility (e.g., one year)
before being allowed to participate in a pension plan.
D. Types of Pension Plans
1. Pension plans can be qualified or nonqualified. A qualified plan is a program
maintained by an employer or employee organization which: (i) provides retirement
income for employees and (ii) qualifies for special tax treatment. Nonqualified plans,
naturally, do not qualify for special tax treatment.
2. Pension plans can be contributory or noncontributory. In a contributory plan, the
employee makes contributions. In a noncontributory plan, the employer makes all the
contributions.
IX. CONSOLIDATED OMNIBUS BUDGET RECONCILIATION ACT OF 1985 (COBRA)
A. In General
The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) allows certain
individuals to continue the group health insurance coverage that they have through an
employer after employment ends. Most former employees will pay 35% of their COBRA
premiums, and the remaining 65% is reimbursed to the coverage provider through a tax
credit (for the first nine months of coverage).
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B. Employers Regulated - Those with 20 or More Employees
Only those employers with 20 or more employees need to comply with COBRA.
C. Benefits Covered - Same Benefits as When Employed
The coverage under the health plan must be identical to the benefits in effect before
termination. For example, if family members were originally covered, they can continue to be
covered at the employee's expense after termination.
D. Coverage Period - Generally 18 Months
Health insurance can be retained for 18 months at the employee's expense. This period may
be extended under certain circumstances.
END OF ANCILLARY MATERIAL
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