reg 6 notes

8/3/2019 REG 6 Notes

http://slidepdf.com/reader/full/reg-6-notes 1/7

2011 Edition - Regulation 6 Class Notes

REGULATION 6

class notes

This lecture covers commercial paper, secured transactions and real property. According to the

AICPA's Content Specification Outline these items and the items found in R4 (business organizations

material), R5, R6 and R7 should make up between 17% and 21% of your Regulation examination.

COMMERCIAL PAPER

I. Approach to Questions

A. Commercial paper is governed by UCC Article 3. Article 3 provides that if commercial

paper is negotiable (i.e., meets specific formal requirements) and it is negotiated (i.e.,

transferred in a particular way), to a holder in due course (i.e., a transferee who meets

certain requirements), the maker or drawer of the commercial paper can avoid paying out

on the instrument only if he/she can raise one of 10 specific ("real") defenses; no other

defense that would be available against an ordinary transferee of a contract right may be

raised against an HDC.

B. There are four important steps to analyze for a commercial paper question:

1. Determine whether the instrument is a note or draft.

2. Determine whether the instrument is negotiable.

3. Determine whether the holder qualifies as a holder in due course.

4. Determine whether the maker/drawer has a "real" or "personal" defense.

II. Terminology (Step 1)

A. Two-party paper - notes - a promise by the "maker" to pay money to the "payee," or

"bearer." Certificate of deposit - issued by a bank acknowledging receipt of money.

B. Three-party paper - drafts - "drawer" orders "drawee" to pay a third party. Checks-

always payable "on demand" and the "drawee" must be a bank. Trade acceptance -

special type of "draft" that is drawn by a seller ordering the buyer to pay. The buyer is

typically the drawee and accepts the instrument for payment.

C. Demand vs. time instrument - An instrument payable on "demand" is a demand note or

draft. An instrument payable at a future date is a time note or draft.

III. Negotiability (Step 2)

A. The front of the instrument determines negotiability.

B. Must meet the technical requirements under the UCC.

1. Be a writing.

2. Be signed by the maker (note) or drawer (draft). The UCC is very liberal about the

signing requirement; it can be a rubber stamp, typed, etc., or any mark affixed with

intent to serve as a signature.

1© 2010 DeVry/Becker Educational Development Corp. All rights reserved.




3. Contain an unconditional promise (note e.g., "I promise to pay") or order (draft e.g.,

"pay") to pay. If the payment is "conditional," the instrument is not negotiable.

4. Be for a fixed amount of money. Not money and/or goods or services. Money only.

With interest (percentage stated or unstated) is okay.

5. Be payable is on demand or at a definite time.

6. Be payable to order or to bearer.

7. Contain no undertaking or instruction not authorized by the UCC.

IV. Negotiation - Holder in Due Course (Step 3)

A. The instrument must be transferred in a proper way. This is called negotiation. The UCC

protects certain transferees - "holders in due course" (HDCs).

B. Steps in becoming an HDC.

1. Become a holder through proper negotiation. A holder is a person with good title to

the commercial paper.

a. Bearer paper requires mere delivery. Order paper requires delivery and

endorsement.

b. Last endorsement on the back of the instrument controls whether it is order

or bearer paper.

c. A special endorsement names a specific party who must endorse for further

transfer. A blank endorsement does not name a new endorsee. A qualified

endorsement contains the words "without recourse" and disclaims contract

liability of the endorser. Restrictive endorsements contain conditions.

d. "Breaking the chain of title" - if a necessary endorsement is missing or forged,

there is a break in the chain of title and no subsequent transferee can becomea holder.

2. Becoming an HDC. A holder will be an HDC to the extent he takes the paper:

a. For value

b. In good faith, and

c. Without notice of any defense to or claims of ownership on the instrument.

C. The Shelter Doctrine - to assure free transferability of commercial paper the UCC provides

that most subsequent transferees of an HDC "take shelter in" the rights of the HDC. A

transferee takes whatever rights his or her transferor has. Therefore, even if the transferee

does not qualify as an HDC in his own right, he can claim the rights of an HDC who held

the note before him.

V. Claims and Defenses on the Instrument

A. REAL defenses - The following defenses can be successfully raised by a maker or drawer

(so the maker/drawer doesn't have to pay) even against an HDC. "FAIDS".

1. Fraud in the execution; forgery of a necessary signature.

2. Adjudicated insanity; material alteration of the instrument.

2

© 2010 DeVry/Becker Educational Development Corp. All rights reserved.




3. Infancy; illegality

4. Duress; discharge in bankruptcy.

5. Suretyship defenses; statute of limitations.

B. PERSONAL defenses - anyone with rights of an HDC gets paid. HDC wins. Any defense

on the CPA exam that is not a "real" defense.

VI. Liability of the Parties

A. Maker = primarily liable

B. Drawer = secondarily liable

C. Drawee = primarily liable after acceptance

D. Endorsers. Contract liability by signing the document - secondary liability (liable if

instrument is presented for payment, is dishonored, and endorser is given notice of

dishonor). Warranty liabilities - made by anyone who transfers the instrument (only to the

immediate transferee if transferor does not endorse; to all subsequent transferees if

transferor endorses) - transferors warrant that the transferor is entitled to enforce the

instrument; all signatures are genuine; the instrument has not been materially altered; no

defenses are good against the transferor; and the transferor has no knowledge of any

insolvency proceedings.

E. Discharge - parties can be discharged from their liabilities

1. By payment, satisfaction or tender of payment to a holder.

2. By cancellation or renunciation.

3. By impairing recourse or collateral.

4. By delay in presentment,

5. By acceptance of a draft by a bank.

SECURED TRANSACTIONS

I. Introduction

A. Secured transaction - a debt guaranteed by collateral.

B. Security interest - allows creditor to take the collateral if debtor fails to pay the secured

obligation.

C. Effective between debtor and creditor upon attachment. Gives creditor the right to seize

the collateral upon the debtor's default.

D. Effective on perfection against third parties who have a conflicting interest in the collateral.

E. Purchase Money Security Interest (PMSI).

1. Special type of security interest that has priority over other types of security interests

in the same collateral, if the PMSI is properly perfected.

2. Creditor sells asset to debtor on credit and retains a security interest in the asset

(collateral) for the purchase price; or the creditor advances funds used by the debtor

to purchase the collateral and retains a security interest in the collateral.

3





F. Types of collateral- determined by how the debtor uses the collateral.

1. Consumer goods - personal use.

2. Inventory (goods held for sale), and

3. Equipment (other goods used in business).

II. Creation (Attachment) of Security Interest

A. 3 requirements for attachment (VAC).

1. Agreement (creates the security interest) evidenced by either an authenticated record

(such as written security agreement or a computer file) or creditor taking possession

of the collateral.

2. Value must be given by the secured party.

3. Debtor must have rights in the collateral.

B. After-acquired property clause - a provision in the security agreement giving the secured

party a security interest in property acquired by debtor after security agreement isexecuted.

III. Perfection of the Security Interest

A. Perfection sets secured party's rights in collateral against third parties who may also have

an interest in the same collateral.

B. Timing of perfection - perfection cannot be completed until there is attachment, but

attachment and perfection may be simultaneous.

C. Ways to perfect

1. Filing - filing a financing statement

2. Possession - not intangibles

3. Control - investment property

4. Automatic perfection - PMSI in consumer goods and small scale assignments of

accounts

5. Temporary Perfection

a. Twenty-day period. A security interest in proceeds from original collateral is

continuously perfected for 20 days.

b. Interstate shipments - four month grace period. Collateral is taken from one

state to another; perfection in the first state is valid for four months in thesecond state. If not perfected in second state during four-month period,

becomes unperfected.

IV . Priorities

A. Buyer of seller's inventory in the ordinary course of business has the highest priority in the

collateral - first place.

4© 2010 DeVry/Becker Educational Development Corp. All rights reserved.




B. Properly Perfected PMSI Second Place.

1. PMSI in consumer goods is automatically perfected upon attachment.

2. A second-hand buyer of consumer goods will take the goods free of an automatically

perfected PMSI as long as the consumer had no notice (for example, the PMSI

holder did not file a financing statement) of the security interest.

3. PMSI in inventory has priority over a prior perfected security interest in the same

inventory if the PMSI is perfected before the debtor gets possession of the collateral

and the holders of other security interests in the collateral receive notice of the PMSI

before the debtor receives the inventory.

4. A PMSI in noninventory collateral (e.g., equipment) has priority over conflicting

security interests in the same collateral as long as the PMSI is perfected within 20

days after the debtor receives the collateral.

C. Perfected security interests and judicial liens that have attached - third place. If there is a

conflict between perfected security interests - the first to file or perfect wins. If there is a

conflict between a perfected security interest and a judicial lien that has attached - the first

to perfect (if security interest) or attach (if judicial lien) has priority.

D. Unperfected security interest - fourth place. If two unperfected security interests conflict,

then first to attach.

E. Debtor - last place.

V. Rights on Default

A. Creditor may take possession of collateral and keep it (see F., below) or sell it.

B. Self-help is OK if no breach of peace.

C. Replevin - a judicial action seeking the transfer of personal property.

D. Sale can be public or private as long as commercially reasonable.

E. Proceeds - pay expenses of repossession and sale; then pay creditors in order of priority

and any surplus goes to the debtor.

F. Creditor may retain the collateral in satisfaction of the debt - if the debtor is a consumer it

will be considered full satisfaction - non-consumer the secured party can still collect any

deficiency - secured party cannot retain the collateral if the debtor has paid at least 60%

then creditor must sell.

SURETYSHIP AND CREDITOR'S RIGHTS

I. Suretyship Obligation

A. Broadly speaking, a surety is one who is liable for the debt or obligation of another.

Suretyship involves three parties: the creditor (i.e., the obligee), the principal (i.e., the

debtor or obligor), and the surety.

B. The Statute of Frauds requires written evidence of the promise to answer for the debt of

another. A suretyship undertaking not evidenced by a written memorandum is

unenforceable.

5





C. A gratuitous surety is one who is not compensated for his promise to the creditor. If the

creditor does anything that varies the gratuitous surety's risk, then the surety's obligation is

discharged.

D. A compensated surety is one who is paid for his promise to the creditor. Only changes by

the creditor that materially increase the surety's risk will release a compensated surety.

II. The Surety's Rights

A . When a debtor defaults in a suretyship situation, the creditor may do any of the following

in any order:

1. Immediately demand payment from the surety.

2. Immediately demand payment from the debtor.

3. Immediately go after collateral if there is any. The surety does not have the right to

require the creditor to take any of the above mentioned action. A guarantor of

collectability would have the right to require a creditor to first proceed against the

debtor or against available collateral.

B. The Rights of Exoneration, Subrogation and Reimbursement.

1. Exoneration: If the debtor fails to pay, the surety may bring a suit for exoneration tocompel the debtor to pay. The surety may do this prior to paying the creditor.

2. Subrogation: Once the surety pays the creditor, the surety may enforce any right that

the creditor has against the debtor. For example, if the creditor was a secured

creditor, the surety would gain the rights of a secured creditor upon payment.

3. Reimbursement: The surety is entitled to reimbursement from the debtor for any

amounts that the surety paid. This is also called the right of "indemnification."

C. Co-sureties are two or more sureties of the same obligation. Co-sureties are jointly and

severally liable (i.e., anyone or more may be liable for the entire obligation).

1. On payment, a surety is entitled to contribution from his co-sureties on their share of

the payment.

2. Where co-sureties are obligated for varying amounts by their agreements and the

debt is reduced by part payment by the principal, each co-surety remains liable for

the original amount stated in his agreement.

3. A release of a co-surety without the other co-surety's consent results in the remaining

co-surety losing the right of contribution against the released co-surety. Thus, the

remaining surety is discharged to the extent that the surety could have recovered

from the released surety.

III. Defenses of a Surety

A. Fraud by the Creditor: The surety may use a defense that the debtor was induced into the

debt agreement by the creditor's fraud. The surety may not use fraud by the debtor to

induce the surety into the debt agreement as a defense unless the creditor was aware ofthe fraud.

B. Duress and Illegality: The surety is not liable if the debtor's promise was obtained by duress

or if the debtor's obligation was illegal.

C. Payment or tender of payment by the debtor or a third party is a valid defense for a surety.

6





D. Extension of Time: The creditor and debtor agree to extend the time of the debtor's

payment.

1. Any extension of time releases a gratuitous surety.

2. A compensated surety is released only if the extension of time materially increased

the surety's risk.

3. If the creditor does not agree to extend time, but merely delays in collection, thesurety is not released.

E. Personal Defenses of the Debtor.

1. The surety may not use as a defense the debtor's infancy, insanity or illegality.

Those defenses are personal to the debtor.

2. The surety may use his own infancy, insanity or bankruptcy as a defense.

IV. Judicial Liens and Garnishment

A. If a debtor is adjudged to owe a creditor money and the judgment has gone unsatisfied, the

creditor can request the court to impose a lien on specific property owned and possessed

by the debtor.

1. After the court imposes the lien, it will issue a writ (e.g., a writ of attachment), usually

to the local sheriff, to seize property belonging to the debtor, sell it, and turn over the

proceeds to the creditor.

2. With personal property liens, the lien usually attaches upon seizure of the property by

the sheriff. Where the property is real property, the lien usually attaches on the date

the judgment is docketed by the court.

B. Where the debtor is adjudged to owe the creditor money and the debtor has property in the

hands of a third party (e.g., money the debtor is owed by his employer, money in a bank

account, debts owed to the debtor), a writ of garnishment may be sought.

1. The writ orders the person holding the property to turn it over to the creditor or be

held personally liable for the value of the property not turned over.

2. Federal law provides that social security payments are not subject to garnishment,

execution, levy, or attachment.

V. Federal Fair Debt Collection Practices Act

A. The Act curbs abuses by collection agencies in collecting consumer debts. The Act does

not apply to a creditor attempting to collect its own debts; just to services that collect

consumer debts for others.

B. The Act severely restricts collection agencies' ability to call third parties, such as relatives of

the debtor, to indirectly pressure the debtor.

C. The act also prohibits:

1. Contacting the debtor at inconvenient or unusual times; in most cases "convenient"

times are between 8:00 am and 9:00 pm.

2. Contacting the debtor directly if the debtor is represented by an attorney.

3. Using harassing or abusive language in talking to the debtor.

We hope you find these tips helpful. Work hard and you will succeed!

7


reg 6 notes

Documents