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Agency
Agency – legal relationship in which one person or entity (the principal) appoints another person or entity (the
agent) to act on his behalf
• To create an agency the principal must have capacity (not a minor or incompetent) and consent
• Writing not required unless impossible to perform in 1 year, or purchase or sale of land
• Agent need not have capacity – minor can be an agent
• Consideration not required
If agent breaches the duties, the principal can recover damages from the agents
Contract damages – principal collects the money/consideration that was paid to agent
Either party generally has the power to terminate the relationship at any time. However, the parties don’t
necessarily have the right to terminate at any time
• Exception: Agency coupled with an interest (agent is a creditor of the principle)
- Principal cannot terminate an agency, only the agent can terminate
An agency relationship arises when the principal appoints an agent to act to his behalf. By this appointment, the
agent can bind the principal in contract.
Type 1: Actual authority – agent reasonably believes he possesses because of the principals communications to
the agent. Actual authority can be either express or implied:
• Express actual authority – oral or written instructions
• Implied actual authority – the authority to do things reasonably necessary (in the ordinary course of
business) to carry out the agency
- Implied authority to hire/fire employees, purchase inventory and pay business debts
- No implied authority to sell business fixtures or borrow money on the principals behalf
Termination of actual authority is automatic by operation of law due to the following events
• Death
• Incapacity of the principal
• Discharge in bankruptcy of the principal
• Failure to acquire a necessary license
• Destruction of the subject matter of the agency
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• Subsequent illegality\
New employees are sub agents, who owe a fiduciary duty to both principal and primary agent
Type 2: Apparent authority – an agent might not have actual authority, but still has the power (not the right) to
bind the principal
• Title/position carries apparent authority
• Failure to give notice to 3rd parties after agent is terminated
A principal’s secret limiting instructions, while effect to limit the agents actual authority, are not effective to
limit the agents apparent authority. (Owner tells manager not to buy inventory over $250, supplier offers
inventory for $300 and manager buys it. The owner must pay the supplier)
Apparent authority is based on the third party’s reasonable belief. that the agent has the power to bind the
principal. While actual authority arises from the agent’s reasonable belief that he has the power to bind the
principal
To terminate apparent authority, principal must give notice to third parties who might have knowledge of the
agency:
• Actual notice – must be given to terminate apparent authority to old customers
• Constructive notice – must be given to terminate apparent authority to new customers
There are situations where apparent authority is terminated by operation of law, and no notice is required:
• Death of principal or agent
• Incapacity of the principal, or
• Principal receives a discharge in bankruptcy
Type 3: Ratification – allows principal to choose to become bound by a previously unauthorized act of his
agent
• All material facts must be disclosed to the principal
• The principal must ratify the entire transaction – there can be no partial ratification
As a general rule a principal is not liable for the torts committed by his agent
Exception: Respondeat superior doctrine – an employer can be liable for an employees torts committed within
the scope of employment
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- The injured party may sue both the employer and employee under this doctrine
An employer is liable for only for torts of an employee and is usually not responsible for torts of independent
contractors, determine by:
• Right to control – control the manner is which the person performs. An employer has the right to control
employees, but has little control over the methods used by independent contractors
• Other factors: provides his own tools and facilities, length of employment, basis of compensation, degree of
supervision
• Exception: an employer can be liable for torts when the independent contractor’s work involves ultra
hazardous activities (blasting)
The employer is usually liable only for an employees negligence and is not liable for intentional torts
Bankruptcy
Chapter 7 liquidation – available to individuals, P/S, and corps
• A trustee is appointed and collects the debtors assets, liquidates them, and uses the proceeds to pay off
creditors to the extent possible
• Debtors debts are discharged
A chapter 7 case by an individual consumer debtor may be dismissed if there is abuse/means. Means/abuse test:
1. Determine avg monthly salary over the previous 6 months prior to filing
- if equal or less than state median income – Chapter 7 permitted
- if debtors income exceeds state median income – means test applied to determine whether debtor has
sufficient income to repay debts using chapter 13
2. Current monthly income * 60 (social security payments not included and certain expenses deductible)
- if less than $6,000 chapter 7 permitted
- if $10,000 or more – presumption of abuse, either chapter 13 or dismissed
- if between $6,000-$10,000 – a presumption of abuse will arise only if this amount equals at least 25%
of the debtors unsecured claims not entitled to priority
Railroads, insurance companies, banks, saving institutions, and small business investment companies may not
file for chapter 7. No RIBSS
Brokers, companies, banks, saving institutions, and small business investment companies may not file for
chapter 11. No BIBSS
Debt relief agencies – agencies paid to assist consumer debtors in filing bankruptcy petitions
• May not advise a person to incur more debt in anticipation of a bankruptcy filing
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When a bankruptcy petition is either voluntary or involuntarily filed, an automatic stay (stops collection
efforts) becomes effective against most creditors
After a petition is filed, if the debtor is an individual, a certificate from the non-profit budget and credit
counseling agency that provided the debtor counseling service, along with any plan of repayment developed by
the agency
Involuntary cases
• Unsecured creditors may petition a debtor into bankruptcy proceedings when the debtor is defaulting (not
paying debts when due)
• Only creditors who are owed, individually or in aggregate, at least $12,300 in unsecured, undisputed debt
may petition debtor for bankruptcy
- If debtor has fewer than 12 creditors, at least 1 creditor must be owed $12,300 to file a petition
- If debtor has more than 12 creditors, at least 3 creditors owed $12,300 in aggregate may petition
Section 341 meeting – within 20-40 days after the order for relief, a meeting of the creditors is held
Fraudulent transfers – any transfer with intent to hinder, delay, or defraud creditors. 2 year looking period
- concealing assets, selling below FMV, gifting items, sell it but keep equitable interest
Preferential transfer rules – prevents one creditor from receiving an unfairly large repayment relative to other
creditors. When the payment is “set aside” by the trustee, the payment is taken back from the creditor who
received it and becomes part of the bankruptcy estate. A preferential payment is:
• A transfer made to or for the benefit of the creditor
• On account of an antecedent (existing) debt of the debtor
• Made within 90 days
• Made while the debtor was insolvent, and
• Results in the creditor receiving more than the creditor would have received under the bankruptcy code
To have a claim against an estate, unsecured creditors must file a proof of claim
There are certain things that will prevent a party from getting a discharge in bankruptcy: DRAWING
• Discharge within 8 years
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• Records, failure to keep
• Assets, failure to explain whereabouts
• Willfully concealing assets
• Not an individual
• Not obeying court orders
• Guilty of a bankruptcy crime
Under chapter 7 and 11, not all debts are discharged. WAFTED
• Willful and malicious injury liabilities
• Alimony
• Fraud
• Taxes
• Educational loans
• Debts undisclosed in bankruptcy petition
The order of payment for the 9 priority creditors: SAG WEG CTI
• Support obligations to spouse and children
• Administrative expenses of bankruptcy proceeding
• Gap creditors (claims that accrue between in ordinary course of business between order of relief and invol.)
• Wages up to $10,000 if earned within 180 days prior to filing
• Grain farmers and fisherman up to $4,925
• Consumer deposits for goods paid but not delivered
• Taxes
• Injuries caused by drunk driving
There are 3 restrictions on priority payments for unpaid wages and unpaid employee benefit plans:
• Only unpaid wages and benefit plans that arose within 180 days prior to filing are entitled to priority. Those
that arose after filing are general creditors and receive no priority
• It is only unpaid wages and unpaid employee benefit plans up to $10,000 that receive priority
• Unpaid employee benefit plans are reduced by any amount paid to the employee for a priority wage claim
Securities Regulation
Securities Act of 1933 – regulates original issues of securities (IPO’s)
Securities Exchange Act of 1934 – regulates purchases and sales after initial issuance
Securities act of 1933 – purpose is to provide investors with sufficient investment information to make an
informed investment decision. The SEC does not guarantee the accuracy of this information or evaluate the
financial merits
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The 1933 act applies only to issuers, underwriters and dealers
Timetable
Before registration – no sales activity allowed
Between registration and filing date (20 day waiting period) – some sales allowed
After registration is effective – securities may be sold
Section 12 and 17 are anti-fraud provisions which also apply to unregistered exempt securities (not for profits)
Section 11 makes anyone who signed the registration statement liable for all damages caused by any
misstatement of material fact in the registration statement. A person wishing to sue need only show:
• The plaintiff acquired the stock (need not be the initial purchaser
• Plaintiff suffered a loss/damages
• The registration statement contained a material misrepresentation or material omission of fact
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Plaintiff need not prove an intent to deceive (scienter), negligence or reliance
Officers, directors, corporate lawyers, underwriters and auditors can be liable
Plaintiff need not be in privity with the defendant under federal law
Defendants, other than issuers, are not liable if they can prove they used due dillegence
For auditors, use GAAP, GAAS defense by showing workpapers
Another defense is to show that misstatement was not material or the plaintiff knew of the omission at the time
they purchased the securities
Reporting requirements
• 10K – filed annually within 90 days of the end of the fiscal year, certified/audited auditors
• 10Q – filed within 45 days of the end of the first three quarters, reviewed by auditors
• 8K – filed within 15 days after a major change in the company
• Any person acquiring 5% must file a report with the SEC
- The report must include background information about the purchaser, the source of funds, and the
purpose in buying
• Insiders (officers, directors, 10% stockholders, accountants, attorneys) must file a report with the SEC
disclosing their holdings and make monthly updates
• Tender offer – an offer to all shareholders to purchase stock for a specified price for a specified period of
time
• Proxy solicitation/statements – a written request for permission to vote a shareholder’s share at a
shareholder meeting
Antifraud provisions Rule 10B-5 – prohibits fraud in connection with the purchase or sale of any security
To recover damages under 10B-5 plaintiff must prove:
• The plaintiff acquired the stock (need not be the initial purchaser
• Plaintiff suffered a loss/damages
• The registration statement contained a material misrepresentation or material omission of fact
• Scienter (intent to deceive or reckless disregard for the truth)
• Reliance
The SEC investigates but does not prosecute. They send evidence to U.S. attorneys office
If CPA breaches the contract, the client or third party beneficiary is entitled to recover compensatory damages
(money to compensate for the contract not having been performed)
- defenses: client failed to cooperate, hindered our performance
Examples are failure to warn the client about known internal control weaknesses or failure to have critical
review at every level of supervision
To whom is the duty owed?
Majority rule – any person or limited foreseeable class of persons whom the CPA knows will be relying on the
CPA’s work
Ultramares decision – limits CPA liability to persons in privity of contract with the CPA and intended third
party beneficiaries
If the auditor detects information of illegal acts, he should inform the clients audit committee of the act
The clients board is to report to the SEC the receipt of any such notice within 1 day after receiving it and must
furnish the auditor with a copy of the notice.
If the CPA fails to receive a copy of the notice within 1 day, the CPA is to furnish the SEC with a copy of the
report within 1 day
Work papers belong to the accountant and is prohibited from showing them to anyone without the clients
permission. Except:
• Subpoenaed
• Voluntary quality control review
• Defend a lawsuit brought by a client
• AICPA/state trail board
Exam trick: if the CPA sells his practice, still need clients permission to disclose the work-papers to new owner
Property Insurance
Public policy requires an insurable interest (must own it) in order to purchase insurance. Note that the
substantial economic interest need not exist when the policy is taken out. It only must exist at the time of loss
Recoverable amount = [Face value of policies ÷ (coinsurance % * FMV of property at time of loss)] * loss
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When there is a total loss, recovery amount/pay out is according to the policy not the coinsurance formula
Subrogation – is the right of the insurer, upon paying the loss, to recover the amount paid from third party who
is at fault (third party started a fire, insurance company paid the damages, then sues third party)