Professional Documents
Culture Documents
Agency, Bankruptcy, Securities, CPA Legal Liability, and Copyrights & Patents
1. Agency 3
2. Bankruptcy 16
3. Securities regulation 39
4. CPA legal liability 53
5. Antitrust law 59
6. Copyrights and patents 67
7. Class questions 71
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Regulation 7
R7-2
NOTES
Becker Professional Education I CPA Exam Review
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Becker Professional Education I CPA Exam Review Regulation 7
AGENCY
I. CREATION OF THE AGENCY RELATIONSHIP
A. Introduction
Agency is a legal relationship in which one person or entity (the principal) appoints another
person or entity (the agent) to act on his behalf.
B. Requisites for Creation
1. Principal with Capacity and Consent
As a general rule, all that is reguired to create an agency relationship is a principal with
contractual capacity (i.e., not a minor and not incompetent) and consent of the parties
(i.e., the parties agree to act as principal and agent).
Thus,
Note the
A l ~ ~ e V ' e " c e
a.
b.
Writing Generally Not Required-Unless to Buy or Sell Land or Impossible
to Perform in One Year
(1) A writing generally is not required to create an agency relationship, even if
the contract that the agent is to enter on the principal's behalf must be
evidenced by a writing under the Statute of Frauds.
(2) However, many states require a written agency agreement if the agent is to
buy or sell an interest in land for the principal.
(3) Note that a contract to find a buyer or seller (normal real estate broker's
agreement) and a contract to build a house are contracts for services. An
oral agency involving such transactions is valid.
(4) Agency agreements that cannot be performed in one year must be
evidenced by a writing.
Agent Need Not Have Capacity-Minors Can Be Agents
Only the principal must be competent. The agent need not have capacity.
a minor or mentally incompetent person can be appointed as an agent.
c. Consideration Not Required
Consideration is not required to form an agency relationship.
PASS KEY
The examiners often ask what is necessary to create an agency. Generally, all you need is consent and a principal
with capacity. A writing is necessary only if the agent will enter into land sale contracts. Thus, an answer that says a
writing is required or the agent's authority must be signed by the principal usually is wrong.
IEIiB
2. Power of Attorney-Written Authorization of Agency
a. A power of attorney is a written authorization of agency.
b. The agent under a power of attorney is referred to as an "attorney in fact." But
the agent need not be a lawyer. It just means that the agent has the power to act
on behalf of the principal.
c. Generally only the(jJrincipal)s required to sign the power of attorney. There is no
requirement that the agent sign the instrument.
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Regulation 7
d.
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The agent's authority is normally limited to specific transactions. 'i..e., veel\l esi-eI\i-e
C. Rights and Duties Between Principal and Agent
Certain duties are implied in every agency relationship.
1. Duties of Agent to Principal F'i.AlAc'i.eI\vy AlAi-y
The agent has whatever duties are expressly stated in his contract. The agent also
owes the following three duties:
- No \c.'i.c\c.bel\c\c.s Ova.
- Avo'i.A
- 1)0,,'i- A'i.sclose
Duty of Loyalty-Act Solely in Principal's Interest
(1) An agent owes her principal a duty of loyalty, i.e., the agent must act solely
in the principal's interest in connection with the agency.
(2) An agent breaches this duty when she has interests adverse to the
principal (e.g., agent obtains kickbacks from a third party).
EXAMPLE
Petshop hired Andy as its store manager and gave Andy authority to purchase pets for the
store. Andy occasionally purchased dogs from Tremendous Dogs. When Andy bought dogs
from Tremendous, it paid Andy 5% of the purchase price as incentive to do more business.
Petshop was unaware of the payments, which Andy kept. Andy has breached his duty of
loyalty and can be forced to turn over his profit to Petshop. IICO"S"lAci-'i.ve "lAsi- I
b. Duty of Obedience-Obey Reasonable Instructions 1)0 "oi- e)CceeA YOlAv
An agent must obey all reasonable directions of his principal. el\lAi-hov'i.i-y
EXAMPLE
Paul hires Audrey as his purchasing agent for televisions, but instructs Audrey not to disclose to
sellers that she is working for Paul. If Audrey discloses to a seller that she is working for Paul,
she breaches her duty of obedience and will be liable to Paul for any damages the disclosure
caused.
R7-4
c.
d.
e.
Duty of Reasonable Care-Liable if Negligent -r pv'i."c'i.peI\l eI\"A "3vA Pel\vi-y
An agent owes her principal a duty to carry out the agency with reasonable care
(i.e., the duty not to be negligent).
Duty to Account
Unless otherwise agreed, the agent has a duty to account to the principal for all
property and money received and paid out when acting on behalf of the principal.
The agent cannot commingle the principal's property with the agent's property.
Subagent
If an agent is authorized to hire a subagent, the subagent owes a duty of care to
both the agent and the principal.
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2. Principal's Remedies
If anlagent breacheslthe duties she owes to her principal, the principal can recover
damages from the agent:
a. (Tortamages
The principal can recover tort damages from the agent if the agent negligently or
intentionally breached a duty owed to the principal.
b. Contract Damages
If the agent was compensated, the principal can collect contract damages. If the
agent did not receive consideration, a contract was not formed and so contract
damages are not available.
c. Recovery of Secret Profits
If the agent obtained a secret profit, as in the example in a., above, the principal
can recover the secret profit, usually b ~ imposing a constructive trusYon the
profit.
d. Withhold Compensation
If the agent committed an intentional tort or intentionally breached her duty to her
principal, the principal may refuse to pay the agent.
3. Duties of Principal to Agent
In addition to any duties expressed in the agency agreement, the principal owes the
agent the following duties:
a. Compensation
Unless the agent has agreed to act gratuitously, the principal has an implied duty
to give the agent reasonable compensation.
b. Reimbursement
The principal also has an implied duty to reimburse (i.e., indemnify) the agent for
all expenses incurred in carrying out the agency.
c. Remedies of the Agent
(1) If the principal breaches her duties to the agent, the agent can bring an
action against the principal for any damages caused.
(2) The agent has a duty to mitigate damages (e.g., a wrongfully fired agent
must seek comparable work to replace lost income).
4. (power)o Terminate Relationship-Generally Terminable at Will
Since an agency relationship is consensual, either party generally has the power to
terminate the relationship at any time. However, the parties don't necessarily have the
(right)o terminate at any time. ~ " e ~ o v bveel\ch
EXAMPLE
Porthos hires Athos as his purchasing agent for nine months, at a salary of $2,000 per month. Either
party can terminate the agency the next day, but a wrongful termination will be a breach of contract.
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''0 poweV'
oV' hi- (2)
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(Exceptio?-Agency Coupled with an Interest eI\ eveAli-OV' P
(1) The principal cannot terminate an agency coupled with an interest. Only
the agent can terminate an agency coupled with an interest.
This arises where the agent has an interest in the subject matter of the
agency, such as where the agency power is given as security. In effect,
the agent has paid for the right to be appointed as the agent, usually by
giving credit.
(3) Death, incapacity or bankruptcy of the principal will not end an agency
coupled with an interest.
ttl- f- E_X_A_M_P_L_E ---1
P borrows $20,000 from A, promising to pay A within a year and appointing A as his agent to
sell Blackacre if Pfails to pay. A's agency is coupled with an interest.
EXAMPLE
P hires A to sell Blackacre in exchange for 5% commission. Phas the power to terminate the
agency at any time because A has not acquired an interest in Blackacre.
II.
leMMiI
Noi- "ecesseI\V'lly i-he V'l.qhi-
CONTRACTUALLY BIND PRINCIPAL
A. Introduction
1. An agency relationship arises when the principal appoints an agent to act on his behalf.
By this appointment, the agent can bind the principal in contract.
2. However, the power to contractually bind the principal can arise in several situations
where a true agency relationship does not exist-a principal may be liable even though
no consensual agency relationship was created.
3. Agency power can arise through:
[
a A grant of actual authority, PoweV' eI\"A
ttl- c
b
.: Apparent authority or estoppel, or]
PoweV' - "oi- i-he V'lahi-
Ratification. v
CD B. {Actual)Authority
Actual authority (sometimes called "real authority" or simply "authority") is the authority the
agent reasonably believes he possesses because of the principal's communications to the
agent. An agent with actual authority has the power and the right to bind his principal. Actual
authority can be either express or implied.
1. (Express}6.ctual Authority oV'eI\l/wV'li-i-e" l"Si-vL\Ctlo"s
Actual authority includes all powers that the principal expressly grants within the "four
corners" of the agency agreement.
R7-6
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2. Implied Actual Authority hel\s hi- eI\\\A powev
a. Actual authority includes not only the authority expressed in the agency
agreement, but also any other authority that the agent could reasonably believe
is implied along with the express grant.
b. This includes the authority to do things reasonably necessary to carry out the
agency (e.g., a person hired to manage a business will usually have authority to
hire employees, buy merchandise, etc.).
c. Implied authority may also include things not necessary or customary, but which
the principal has repeatedly allowed the agent to do.
d. Implied authority includes the authority to handle emergencies when no other
instructions are given.
PASS KEY
The examiners have tested on the implied authority of albusiness number of times. The
key is to remember that the manager is there to run the business, not destroy it. Thus, she has
authority to hire and fire employees, purchase inventory, and pay business debts. She has no implied
authority to sell or mortgage business fixtures or other property of the principal (other than
inventory). Also remember that generally an agent does not have implied authority to borrow money
on the principal's behalf-such authority must be expressed.
3. Termination of(Actual Authority)can Occur By:
a. Act of the Parties qL\li-S ov
(1) Termination of an agency can occur through the acts of either the principal
(a revocation) or the agent (a renunciation). Of course, the termination
could violate the parties' contract, in which case damages could be
available.
b.
(2) Exception: Agency Coupled with an Interest
If the agency is coupled with an interest, only the agent, not the principal,
has the power to terminate the agency relationship.
Accomplishment of Objective or Expiration of Stated Period
(1) If the agency is for a limited purpose (e.g., Phil appoints Andrea to
purchase Blackacre for him), actual authority is terminated when the
objective is accomplished (i.e., Andrea purchases Blackacre).
(2) If the agency is for a stated period (e.g., six months), actual authority is
terminated upon expiration of the period. If no time is stated, the actual
authority terminates after a reasonable time.
Termination of Actual Authority By "opevel\i-'i.o\\ lel\w" - see t:t
Actual authority is terminated by the following events: AL\i-olMeI\i-'i.c
(1) Death of either the principal or the agent;
(2) Incapacity of the principal;
(3) Discharge in bankruptcy of the principal;
(4) Failure to acquire a necessary license;
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Regulation 7 Becker Professional Education I CPA Exam Review
(5) Destruction of the subject matter of the agency (e.g., Paula hires Alex to
purchase an antique car, which is destroyed before it can be purchased);
or
(6) Subsequent illegality (e.g., Paula hires Alex to purchase an antique
machine gun, but before the gun can be purchased Congress passes a law
prohibiting private ownership of machine guns).
-------------------------------
PASS KEY
Termination of agency by operation of law is a heavily tested issue. Be sure to memorize the
above list.
@ c.
III
R7-8
Apparent Authority
Even though an agent might not have actual authority, there are situations where the agent
will nevertheless have power (but not the right)lto bind the principal, either because the
principal's conduct has caused third parties to reasonablv believe the agent had authority or
because the principal was negligent and so will be estopped from denying that the agent had
authority. This power to bind the principal is known as apparent authority.
1. Principal's Conduct eI\ tiHe ov pOSH"'iO\\
a. Note that apparent authority requires a holding out by the principal or negligent
inaction by the principal.
b. The purported agent's mere representation that he is an agent is not sufficient to
establish apparent authority. V\\veel\so\\eI\ble "3vA Pel\vTy to
2. Distinguish from Actual Authority tel\\c.e \NovA it
a. Apparent authority is based on the third party's reasonable belief that the agent
has the power to bind the principal.
b. Actual authority arises from the agent's reasonable belief that he has the power
to bind the principal, not the third party's belief.
c. In either case the principal is bound. However, if the agent lacked actual
authority, the principal can hold the agent liable for acting without authority.
3. Common Apparent Authority Situations
a. Apparent Authority from Position /li.He
A principal who holds another out as his agent vests the agent with the power to
enter into all transactions that a reasonable third party would believe a person in
the agent's position would have.
EXAMPLE
Pam hires Alex to manage her pet store. Alex has the apparent authority to hire and fire
employees, make deposits, etc.
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(1) Secret Limiting Instructions Not Effective -r0 c:l\l.\tl-\ovtty
Since apparent authority is based on what the third party reasonably
ttl- believes, the principal's secret limiting instructions-while effective to limit
the agent's actual authority-are not effective to limit the agent's apparent
authority. V\\less "3V'A PeI\V'Ty \\OT-lCe i-he lltMli-
EXAMPLE
Pam hires Alex to manage her pet store. It is customary in the area for pet store
managers to have actual authority to purchase inventory (pets). Pam tells Alex that he
may purchase pets for the store, but may not purchase a pet for more than $200. Tom,
a dog breeder, offers to sell Pomeranian puppies to the pet store for $250 each, and
Alex accepts. Alex has apparent authority to purchase the puppies, but not actual
authority. Thus, Pam will have to pay Tom for the puppies, but can hold Alex liable for
any loss that results.
(2)
General vs. Special Agent
A general agent is an agent engaged to perform a series of transactions
involving a continuity of service. A special agent is one engaged to
perform one or more transactions not involving a continuity of service. A
general agent's apparent authority is broader than a special agent's
apparent authority.
Notice Generally Required to Terminate Apparent Authority
When a principal terminates an agent's actual authority, the agent will continue to
have apparent authority to perform until the principal notifies third parties who
might have known of the agency.
(1) 0ctual notice)must be given to terminate apparent authority to old
customers.
(2) (Constructive notice)must be given to terminate apparent authority to new
customers. AlL
ci-L\eI\ el\L\i-nOV'lTy i-eV'tMl\\eI\i-eA
,
I EXAMPLE
Allen has been patt:t<office managei)for 10 years and has regularly purchased office supplies
from Terri. Patty fires Allen, but does not notify Terri. If Allen purchases more office supplies
from Terri purportedly on Patty's behalf, Terri can mlake Patty pay for the supplies because of
Allen's apparent authority.
Ap'peI\V'e\\i- el\L\i-hoV'lTy CO\\T-l\\L\eS
4. Termination of Apparent Authority by Operation of Law-No Notice E"cepT-lo\\
a. As a general rule, to terminate an agent's apparent authority, there must be some
act that prevents the third party in question from reasonably believing that the
agent has authority. This usually requires notice of the termination, limitation on
authority, etc.
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Regulation 7
b.
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However, apparent authority is terminated by operation of law, and no notice is
required, if any of the following occur:
~ 4 .
D.
(i) Death of the principal or agent;
(ii) Incapacity of the principal; or
(iii) The principal receives a discharge in bankruptcy.
Ratification Powev blAi- \\oi- i-he v l ~ h i -
Ratification allows a principal to choose to become bound by a previously unauthorized act of
his agent.
1. Requirements
a. The agent must have indicated that he or she was acting on behalf of the
principal (if the third party did not believe the agent was acting for a principal,
there can be no ratification).
b. All material facts must be disclosed to the principal.
c. The principal must ratify the entire transaction-there can be no partial
ratification.
Note that ratification does not require consideration and that the principal need not
notify the third party of the ratification (since the third party already thinks he has a
contract with the principal).
2. May Ratify Expressly or Impliedly
The principal may ratify expressly, or may ratify impliedly by accepting the benefits of
the contract when there is an opportunity to reject them.
3. What May Be Ratified?
Generally, any act may be ratified unless:
a. Performance would be illegal;
b. The third party withdraws prior to ratification; or
c. There has been a material change of circumstance so that it would not be fair to
hold the third party liable.
Only a Disclosed Principal May Ratify
a. Only the purported principal may ratify. The agent cannot take over the contract
for himself.
R7-10
b. Only a disclosed principal may ratify. An undisclosed principal cannot ratify.
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WILL AGENT'S ACTS BIND THE PRINCIPAL?
Was there express or implied
actual authority (authority the
agent reasonably believes he/she
YES
The principal will
possesses based on his/her
be bound.
dealings with the principal)?
1NO
Was there apparent authority
(authority the third party
reasonably believes the agent
YES
The principal will
.
has based on the third party's
be bound.
dealings with the principal)?
1NO
Did the principal ratify the
contract after the agent entered YES
The principal will
into it on the principal's behalf be bound.
and before the third party
withdrew?
1NO
The principal will not be bound.
vs.
V\\AlscloseA
PVl\\ClpeI\l
llel\ble O\\ly
hel\s el\ci-L\eI\l
el\L\i-hOVlT-y
E C t t I L
" b"l"t Aci-L\eI\l ov AppeI\ve\\i-
. on rac ua la I I Y ",If
1"/Principal Liable if Agent Had Authority or Principal Ratified
t)lscloseA The principal will be bound by the agent's acts if the agent acted with actual authority or
apparent authority, or if the principal ratified the transaction.
2" Agent's Liability -r0 "3vA PeI\VT-y CO\\i-vel\ci- AL\i-les
a. Disclosed Principal-Agent Not Liable if Authorized
(1) If the agent discloses the existence and identity of the principal (a
disclosed principal situation), the third party cannot hold an authorized
agent liable on the contract.
(2) Every person representing himself as an agent impliedly warrants that he
has the authority he purports to have. If in fact the agent has no such
authority, the third party can hold the agent liable for any damages caused
based on breach of this implied warranty.
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b.
Regulation 7
IBIII
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Pllel\ble eI\$ Wen
Partially Disclosed and Undisclosed Principal-Agent Liable Ahel\.::A el\ci-L\eI\l
If the principal's identity is not disclosed to the disclosed el\L\i-hOV'lTy
principal situation) or neither the existence nor the identity of the principal is O\\ly
disclosed to the third party (an undisclosed principal situation), the agent is liable
on the contract with the third party.
(1) Third Party's Election
The third party can hold either the principal or the agent liable if the
principal was undisclosed or partially disclosed, but not both. The third
party must elect whom to hold liable.
(2) No Apparent Authority with an Undisclosed Principal AlI\.tA lI\.O elthev
If the principal is undisclosed, there can be no apparent authority because
there is no holding out of the agent by the principal.
(3) No Effect on Actual Authority
The fact that the principal is undisclosed has no effect on the agent's
actual authority since actual authority arises from the communications
between the principal and the agent.
PASS KEY
The examiners often ask about undisclosed principal situations. There are a few key points to
remember.
The principal is bound if the agent had authority. It is irrelevant whether the principal was
disclosed, partially disclosed or undisclosed. If the agent did not have authority, the
principal is bound only if he ratifies.
The agent can be held personally liable if the principal is partially disclosed (identity is not
disclosed) or undisclosed (neither identity nor existence are disclosed).
3. Third Party's Liability
a. Generally Only Principal Can Hold Third Party Liable
As a general rule, only the principal (not the agent) can hold the third party liable
on a contract the agent entered into on the principal's behalf, even if the
principal's existence or identity were not disclosed.
EXAMPLE
Ann entered into a contract with Top Corp. to purchase televisions on behalf of Paul. Paul
instructed Ann to enter into the contract in her own name without disclosing that she was
acting on behalf of Paul. IfTop repudiates the contract, Paul may hold Top liable even though
it did not know it was dealing with Paul.
b. Exceptions
The principal cannot hold the third party liable where:
(1) The principal's identity was fraudulently concealed (e.g., if the third party
indicates that he will not do business with the principal, the principal cannot
get around this by dealing through an agent); or
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.......
...
3.
(However)there is an exception for employers. Under the doctrine of respondeat
superior, an employer can be liable for an employee's torts committed within the scope
of employment.
This does not relieve the agent of liability. The injured person may sue both the
employer under respondeat superior and the agent.
Employer-Employee Relationship
An employer (or master) is liable only for torts of an employee (or servant) and is
usually not liable for torts of independent contractors.
(2) The performance to the principal would increase the burden on the third
party (e.g., Goodyear cannot employ a small rubber manufacturer as an
agent to enter into a rubber requirements contract without disclosing that
the contract is for Goodyear).
el\ci- <
(TORT).IABILITY
A. In General-Respondeat Superior
1. As a general rule a principal is(not liable)for the torts committed by his
agent-only the agent is liable.
III.
B.
1. Right to{ControDManner of Performance is Key
The most important factor in determining whether a person is an employee or an
independent contractor is the right of the principal to control the manner in which the
person performs. An employer has the right to control employees, but has little control
over the methods used by independent contractors.
2. Additional Factors
Where right to control is not clear, the courts look to other factors, such as whether the
worker has a business of his own, provides his own tools and facilities, length of the
employment (short or definite vs. long or indefinite), basis of compensation, and the
degree of supervision.
a. A clear example of an employee is one who works full time for the employer,
uses the employer's facilities or tools, is compensated on a time basis, and is
subject to the supervision of the principal. Wee\c.ly/hOL\V'ly
b. A clear example of an independent contractor is one who has a calling of his own
and who uses his own facilities or tools, is hired for a particular job, is paid a
given amount for that job, and who follows his own discretion in carrying out the
job.
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Regulation 7
<Step 2 c.
1."'1
.. .
Becker Professional Education I CPA Exam Review
Scope of Employment
An employer is not liable to an injured party merely because an employee caused the injury-
the injury must also have occurred within the scope of the employment. That is, the injury
must have occurred while the employee was working for the employer within the time and
geographic area in which the employee was to work.
1. Activities
The conduct causing the injury need not actually have been authorized by the
employer; rather the conduct need only be:
(i) Of the same general type the employee was hired to perform; and
(ii) Actuated, at least in part, by a desire to serve the employer.
EXAMPLE
While a bar owner might not authorize a bouncer to beat up boisterous customers, the owner
nevertheless can be held liable if this occurs, because the conduct is of the same general nature as the
bouncer's job.
a. Intentional Torts
(1) The employer usually is liable only for an employee's negligence and is not
liable for intentional torts, since intentional torts are seldom within the
scope of employment.
(2) However, where the tort is authorized or where use of force is authorized
(as with a bouncer), the employer can be liable.
b. Crimes
An employer generally is not liable in tort for an employee's conduct that
constitutes a serious crime (e.g., carrying an illegal weapon).
PASS KEY
The examiners often ask about a principal's liability for its agent's torts. Remember, if the agent is an
employee and committed a tort while trying to serve the principal/employer, the principal/employer
generally will be liable unless the tort was unexpected (e.g., illegal conduct).
2. Time and Geographic Area
It is not enough simply that the conduct that caused the injury was of the same general
type the employee was hired to perform. The conduct must also have occurred within
usual employment time and space limits.
R7-14
a.
b.
Small detours from an employer's directions (e.g., driving a few blocks out of the
way, stopping for lunch, etc.) fall within the scope of the employment.
Major detours (frolic) from an employer's directions (e.g., driving 15 miles out of
the way to attend a party) fall outside the scope of employment.
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3. Cannot Limit Liability by Agreement with Employee
An agreement between the employer and employee that the employer will not be liable
for employee torts does not prevent a third party from holding the employer liable. The
employer can seek reimbursement from the employee.
ANCILLARY MATERIAL (for Independent Review)
1....1
-
d. Employer Liability for Independent Contractors
1. Although the general rule is that an employer is not liable for torts
committed by independent contractors, there are certain situations where the employer
can be held liable for torts of independent contractors.
2. For example, an employer can be liable for the torts of an independent contractor if the
employer authorized the tortious act or if the work involved an ultrahazardous activity.
3. These exceptions are rarely tested.
END OF ANCILLARY MATERIAL
LIABILITY OF PRINCIPAL FOR AGENT'S TORTS
Is the agent an employee or
an independent contractor
(look chiefly to the extent of
the principal's control over
the manner and method of
the agent's performance)?
E . ~
Was the act within the scope
of employment (i.e., was the
employee where he/she was
supposed to be, doing what
he/she was supposed to be
doing, with the purposes of
the employer in mind)?
~ INDEPENDENT
~ R A C T O R
Generally, the principal is not
liable for the torts of an
independent contractor.
The principal
is liable.
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The principal
is not liable.
R7-15
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Regulation 7 Becker Professional Education I CPA Exam Review
BANKRUPTCY
2.
I. INTRODUCTION
A. Types of Bankruptcy Cases
1. Five Types of Bankruptcy Cases
There are five basic types of bankruptcy cases under federal law: Chapter 7-
liquidation; Chapter 9-municipal debt adjustment; Chapter 11-reorganization;
Chapter 12-family farmers with regular income; and Chapter 13-adjustment of debts
of individuals with regular income.
Chapter 7 Liquidation-Trustee Appointed I, P, C
a. In a Chapter 7 liquidation case, a trustee is appointed. The trustee collects the
debtor's assets, liquidates them, and uses the proceeds to payoff creditors to the
extent possible.
I-I
3.
4.
b. If the debtor is an individual (or a married couple), the debtor's debts are then
discharged, with certain exceptions. by AebtoV' thi.s V'eel\SO\\
c. If the debtor is an artificial entity (e.g., a corporation), it is dissolved. No
discharge is given but the effect is the same-the debts are wiped out.
Chapter 13 Adjustment of Debts of Individuals with Regular Income I O\\ly - V01",\\tel\V'Y
a. In a Chapter 13 case, the debtor repays all or a portion of his debts over a three-
year period to a maximum of a five-year period. thi.s V'eel\SO\\
b. Although there is not a liquidation, a Chapter 13 trustee oversees the handling of
a Chapter 13 proceeding.
c. At the conclusion of a Chapter 13 proceeding, the remaining debts of the debtor
are discharged. u
nOpe
Chapter 11 Reorganization-No Liquidation, Trustee Not Required I, P, C
a. In a Chapter 11 reorganization case (usually used by businesses but also
available to individuals), a trustee usually is not appointed.
b. The debtor remains in possession of his or her assets and a plan of
reorganization (i.e., a plan to payoff debts at a different time and/or different
amount than originally due) is adopted.
c. Creditors are paid to the extent possible and the business continues.
PASS KEY
The examiners often ask if a trustee is required for a particular type of bankruptcy. There are a few key points
to remember.
A trustee is required for Chapter 7 and Chapter 13.
A trustee is not required for Chapter 11, although the court may appoint one if one is needed.
R7-16
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B. Dismissal or Conversion of a Chapter 7 Case - The Means Test (\\A'i.v'i.AL\eI\lS O\\ly
A Chapter 7 case by ani individual consumer debtorlmay be dismissed (or with the debtor's
consent converted to a case under Chapter 13) upon a finding that granting relief under
Chapter 7 would constitute abuse. Abuse may be determined by a specific means test or by
a more general abuse test.
, 1. Calculation of Debtor's Income
To determine if the debtor has sufficient income to pay some or all of their debts under
a Chapter 13 plan, a calculation of the debtor's income is made.
1)ebi-oV' hel\ppy
If Equal To or Less Than State Median Income - Chapter 7 Permitted
If the debtor's average monthly income multiplied by twelve plus that of the
debtor's spouse (even if the spouses do not file jointly) is at or less than
the median income for similarly sized families in the debtor's state, the
debtor can file for Chapter 7 relief.
Current Monthly Income -{Average)of 6 Months Preceding Filing
The first step is to determine the debtor's current monthly income based on the
debtor's average income over the six months prior to filing. The average monthly
income is compared to the median income for a similarly sized family in the
debtor's state (determined by the Bureau of Census).
(1 )
a.
r----(2) If Debtor's Income Exceeds State Median Income - Means Test
Applied
If the debtor's average monthly income multiplied by twelve exceeds the
median family income of similarly sized families in the debtor's state, the
court, the trustee and any other interested party (e.g., a creditor) may file a
motion to dismiss based on the "means test" or a general finding of abuse.
(3) Monthly Income Multiplied by Twelve
The monthly income figure is multiplied by 12 because median family
income for the various states is determined by the Bureau of Census on an
annual basis.
2
b. Means Test
The means test is designed to determine whether the debtor has sufficient
income to repay debts using a Chapter 13 plan. ]
Net v - )C '0
(1) Current Monthly Income Multiplied by 60
The debtor's current monthly income (using a six-month average) is
multiplied by 60. Social security payments are not included in monthly
income and certain expenses are deductible. Sixty months is used
because this is the maximum number of months a Chapter 13 plan may
last.
(2) If Less Than $7,025 - Chapter 7 Permitted 1)ebi-oV' hel\PPY
If the debtor's average monthly income less allowable expenses multiplied
by 60 is less than $7,025, the debtor may file for Chapter 7 relief.
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I\\AlVlAL\eI\ls
Chel\pi-ev 7 ok tw\l Pel\si- , tMo\\i-hs si-eI\i-e tMeAlel\\\
Ov "\\ei-" tw\l )C '0 7
__
ltMS
Chel\pi-ev \"3
(3) If $11,725 or More - Presumption of Abuse \"3 ov AlStMlSSeA
If the product is $11,725 or more, a presumption of abuse occurs. Unless
the presumption is rebutted, the debtor may not file for Chapter 7, but may
file for Chapter 13.
(4) If Less Than $11,725, but $7,025 or More - Abuse Only if Amount
Equals 25% of Non-priority Claims
If the product is less than $11,725, but at least $7,025, a presumption of
abuse will arise only if this amount equals at least 25% of the debtor's
unsecured claims not entitled to priority payment (unsecured claims
entitled to priority payment will be discussed later).
ANCILLARY MATERIAL (for Independent Review)
c. Allowable Deductions
The debtor is allowed to deduct the following from monthly income:
(1) Living Expenses in Amounts Set by the IRS
The debtor may deduct living expenses (e.g., food, clothing, personal care,
entertainment, transportation and housing) in amounts set by the IRS.
(2) Health and Disability Insurance and Health Savings Accounts
Expenses for health insurance costs, disability insurance costs, and health
savings account expenses are deductible for the debtor, spouse and
dependents if reasonably necessary.
(3) Care of Elderly, Disabled, and Chronically III
Reasonable and necessary payments are deductible for the care of
household members or immediate family members, including parents,
grandparents, siblings, children, grandchildren, dependents, and
nondependent spouses in a joint case.
(4) Expenses to Keep Debtor of Family Safe from Family Violence
Expenses are deductible that are reasonably necessary to keep the debtor
and family safe from family violence.
(5) Actual Expenses to Administer a Chapter 13 Plan
If the debtor is eligible for Chapter 13, the actual expenses of administering
a Chapter 13 plan are deductible up to a maximum of 10% of the projected
plan payments.
(6) Expenses for Dependents to Attend Elementary or High School - Up
to $1,775
The actual expenses (up to $1,775) for each dependent child under age 18
to attend elementary or high school are deductible.
(7) 1/60
th
of Payments Due Secured Creditors
One-sixtieth of the payments due to secured creditors during the five years
after filing are deductible. This also includes past due amounts secured by
property necessary to support of the debtor or the debtor's family.
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(8) 1/60
th
of Amount of Priority Claim Payments
One-sixtieth of the amount of priority claim payments is deductible. (Priority
claims are discussed below, in the Chapter 7 materiaL)
2. Rebutting the Presumption of Abuse
a. Rebuttal by Showing Special Circumstances
The debtor may rebut the presumption of abuse by showing special
circumstances (e.g., serious illness or call to active military duty) that create
additional expenses or a need to adjust current monthly income.
b. Additional Expense Must Place Debtor Below Threshold Amount
To rebut the presumption, the additional expenses must place the current
monthly income below the dollar amounts that trigger the presumption of abuse.
3. Exception - No Presumption of Abuse for Disabled Veterans
A Chapter 7 case may not be dismissed or converted based on means testing if the
debtor is a disabled veteran whose indebtedness occurred primarily while he was on
active duty or performing homeland defense activities.
4. General Abuse Test
a. Requires Bad Faith or Totality of Circumstances Indicates Abuse
Even if the debtor qualifies for Chapter 7, relief may be denied by a showing that
the debtor acted in "bad faith" or that under the "totality of circumstances" there
is abuse.
b. Only Raised by the Court, Trustee or Bankruptcy Administrator
If the debtor's average monthly income or the monthly income of the debtor and
debtor's spouse in a joint case is at or less than the median income in the
debtor's state, a Chapter 7 filing can only be dismissed by the general abuse test
and only by the court, trustee or bankruptcy administrator (not a creditor).
5. Dismissal upon Conviction of Violent Crime or Drug Trafficking
A court may dismiss a Chapter 7 filing by a debtor convicted of a crime involving
violence or drug trafficking.
END OF ANCILLARY MATERIAL
C. Who May Be a Debtor
Only a person who resides, or has a place of business, in the United States is eligible to be a
debtor under the Bankruptcy Code. "Person" generally includes individuals, partnerships,
corporations, and the like.
1. Limitation in Chapter 7 Liquidations No
@3ilroads,@vings institutions.@surance and small business
investment companies may not file for bankruptcy under Chapter 7.
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Regulation 7 Becker Professional Education I CPA Exam Review
2. Compare Chapter 11 Reorganizations No B I B ~
ReI\ilvoel\A ok
Bvo\c.evs "0
a. Anyone who can be a debtor (except a stockbroker or commodity broker) under
Chapter 7 may also be a debtor under Chapter 11. Additionally, railroads may be
a debtor under Chapter 11.
b. Although Chapter 11 is intended primarily for business debtors, an individual is
eligible for relief under Chapter 11.
ANCILLARY MATERIAL (for Independent Review)
3. Credit Counseling Required if Debtor is an Individual
a. Counseling must occur no more than 180 days before filing the bankruptcy
petition.
b. Pre-petition counseling may be waived if services could not be obtained within 5
days of requesting such services; however, in such a case the debtor must
receive counseling within 30 days after the petition is filed.
c. Counseling also may be waived due to active combat duty, disability, or
incapacitation or it is determined that credit counseling agencies are not
reasonably available within the district.
d. In addition, debtors filing under Chapter 7 or 13 must complete a financial
management course before their debts are discharged.
D. Duties of Debt Relief Agencies
The Bankruptcy Code imposes duties on debt relief agencies (i.e., agencies that are paid
compensation to assist consumer debtors in filing bankruptcy petitions). A debtor is
considered to be a consumer debtor if his debts are primarily consumer in nature and he has
less than $164,250 in nonexempt property.
1. A debt relief agency must enter into a written contract with a debtor within five business
days after the first date on which the agency provides bankruptcy assistance and
before filing a petition. The contract must explain the services to be provided, fees and
charges, and payment terms.
2. A debt relief agency may not advise a person to incur more debt in anticipation of a
bankruptcy filing.
3. A debt relief agency that breaches the above duties may be subject to an action for
actual damages, costs, loss of fees, and/or an injunction.
END OF ANCILLARY MATERIAL
LiqL\iAeI\T-lO" Reov.qel\"iz.e
II. COMMON FEATURES OF CHAPTER 7 AND CHAPTER 11 CASES I, P, C
A. Automatic Stay-Stops Collection Efforts
I_I 1. When a bankruptcy petition is filed in either a voluntary case or an involuntary case, an
automatic stay becomes effective against most creditors.
R7-20
2. The stay stops almost all collection efforts (e.g., filing a law suit or simply demanding
payment).
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3. The automatic stay does not apply to criminal prosecutions, paternity suits, and cases
brought to establish spousal or child support obligations.
B. Duties of(Debtor) Be ope" eI\"A ho"esi-
After a petition is filed, a debtor must file:
1. A list of creditors and their addresses;
2. A schedule of assets and liabilities; Ai- Ftw\v
3. A schedule of current income and expenditures;
4. A statement of the debtor's financial affairs;
5. Copies of pay stubs received within 60 days before filing;
6. An itemized statement of monthly net income;
7. A disclosure of any reasonably anticipated increase in income or expenditures for the
twelve months after filing;
8. Copies of federal tax returns from the last tax year. If the debtor has not paid taxes for
the previous tax year, he or she must do so before the bankruptcy can proceed.
9. A record of any interest that the debtor has in an education IRA or a qualified state
tuition program;
10. If the debtor is an individual, a certificate from the nonprofit budget and credit
counseling agency that provided the debtor credit counseling services, along with any
plan of repayment developed by the agency; and
11. If the debtor is an individual and has debts secured by property, a statement of her
intention with respect to the property (i.e., the debtor must specify whether she intends
to retain or surrender the property, claim it as exempt, redeem it, or reaffirm the debt).
Note: If in a voluntary Chapter 7 case fails to file any of the items
specified in 1-7, above, within 45 days after filing the petition, the case is automatically
dismissed on the 46th day.
The debtor need not be insolvent to file. However, as previously discussed, a
Chapter 7 case may be dismissed if the debtor has too much income. I\\AlV. \'3
I, P, C
Chapter 7 and Chapter 11 May Be Voluntary or Involuntary Chel\pi-eV' \"3 -
1. Voluntary Cases 'i."A'i.v'i.AL\eI\lS eI\"A
a. Debtor Files for Order of Relief V01L\"i-eI\V'Y o"ly
A voluntary case under Chapter 7 or Chapter 11 is commenced by the debtor
filing a petition for relief. Debts o-P \\ot o-P
Debtor Need Not Be Insolvent - But Must Pass Income Tests AL\e
C.
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c. Spouses May File Jointly
Spouses may file jointly to avoid duplicative fees.
PASS KEY
While it may seem trivial, "spouses may file jointly" often appears as a correct answer on the
CPA examination.
Fewer Than 12 Creditors -1 or More Owed $14,425
COtMpeI\V'e to
Voluntary Petition Constitutes an Automatic Order for Relief 1 L
l"VO ""rel\V'y
A filed voluntary petition constitutes "an order for relief," which simply means a
case can proceed unless a court orders otherwise.
Involuntary Case Not \"3
d.
Only creditors who are owed, individually or in aggregate, at least $14,425 in
unsecured, undisputed debt may petition a debtor involuntarily into bankruptcy.
The number of creditors who must file depends on the debtor's total number of
creditors.
(Unsecured creditors)may petition a debtor involuntarily into bankruptcy proceedings
under Chapter 7 or Chapter 11.
a. Grounds - Generally Not Paying Debts When Due 11("
For an involuntary petition, creditors must show that the debtor generally is not
paying his or her debts as they become due.
b. Ineligible Debtors - Farmers and Charities
Farmers and nonprofit charitable organizations may not be petitioned
involuntarily into bankruptcy.
Who Must Join Petition - Owed At Least $14,425
If a debtor has fewer than 12 creditors, anyone or more creditors who are
owed at least $14,425 in unsecured debt may file.
EXAMPLE
Dee has four creditors she is not paying. Alex is owed $15,000, Bob is owed $4,000, Carla is
owed $4,000, and Sam is owed $17,000, which loan is secured by Dee's $20,000 car. Alex must
join in an involuntary petition; Bob and Carla's claims are not sufficient. Sam may not file.
Sam's claim is adequately secured.
R7-22
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e.
(2) 12 or More Creditors - 3 Owed $14,425
If a debtor has 12 or more creditors, at least three creditors who are owed
at least $14,425 in aggregate, in unsecured, undisputed debt must join in
the involuntary petition.
PASS KEY
The number of creditors and amounts owed necessary to file an involuntary petition is a
favorite exam issue. Two points should be noted:
Usually the examiners use this information to create "distracters" (i.e., wrong answers),
such as "To file a voluntary petition, a debtor must owe at least $14,425" or "have at least
12 creditors." You should take time to memorize the $14,425 and one or three creditor
minimums. Remember, they apply only to involuntary petitions.
If a problem states the number of creditors that a debtor has, the examiners frequently
asked the number needed to file an involuntary petition. Spot in the questions statements
like "the debtor has 19 creditors" or "the debtor has 8 creditors."
d. An Involuntary Petition Does Not Constitute an Order for Relief
(1) Unlike a voluntary petition, an involuntary petition does not constitute an
order for relief. There is the filing and the order of relief
called the involuntary case gap.
(2) The court will enter an order for relief if the debtor does not object to the
petition within 20 days.
(3) If the debtor does object, a hearing is held to determine the debtor's
solvency. The test for solvency is whether the debtor is generally paying
his debts as they become due.
(4) Persons who become creditors of the debtor during the involuntary case
gap period are given high priority in recovering against the debtor's estate. "32
Dismissal of Petition - Damages FVlV010L\S
If improperly filedIan involuntary petition (e.g., insufficient number of
creditors, insufficient unsecured claims, debtor was paying debts as they became
due, etc.) a court may award the debtor compensatory damages, court costs,
attorney's fees, and even punitive damages if bad faith can be shown.
----------------------------------
PASS KEY
Odd as it may seem, the Bankruptcy Code does not require a debtor to be insolvent to file for
bankruptcy. A voluntary petition may be filed by anyone who owes debts, and an involuntary
petition may be filed if the debtor is genera/ly not paying debts as they become due,
regardless of the debtor's ability to pay. An answer choice that suggests that the debtor must
be insolvent to file for, or be petitioned into, bankruptcy is wrong, but be sure to remember
that an individual consumer debtor's Chapter 7 case may be dismissed or converted to Chapter
13 if his income is too high.
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Regulation 7 Becker Professional Education I CPA Exam Review
D.
E.
(2)
Be -
Ao "oi- "eeA
i-o tMetMoV'lz.e
The exemptions most likely to appear are: (i) homestead (up to $21,625 of
residence property); (ii) motor vehicle (up to $3,450); (iii) household goods,
crops, and animals ($550 per item, up to $11,525 in total); (iv) unmatured
life insurance contracts; (v) tools of a trade or professional books (up to
$2,175); (vi) health aids; (vii) government benefits, such as social security,
veteran's benefits, unemployment compensation, and disability benefits;
and (viii) alimony, support, or maintenance (reasonably necessary for
support).
E)CetMptlo"s Ao "oi- el\pply i-eI\)C lie"
R7-24
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~ (2)
3. Trustee's Powers as a Lien Creditor
a. Trustee is a Hypothetical Lien Creditor as of Filing Date
(1) The trustee is treated as having a lien on all of the debtor's property the
instant the bankruptcy petition is filed.
This means that the trustee has priority over all creditors except creditors
with prior perfected security interests or prior statutory or judicial liens.
b. Caution-PMSI in Noninventory Collateral May Have Priority
The trustee will not prevail against PMSls in noninventory collateral that are
validly perfected under state law and within 30 days after the debtor receives
possession of the collateral. Recall, however, that in most states such perfection
is not valid under state law unless it occurs within 20 days after the debtor
receives possession of the collateral.
EXAMPLE
On July 1, Sue sells and delivers to Dan on credit certain equipment and properly reserves a
security interest in the equipment. On July 5, Dan files a petition in bankruptcy. On July 9, Sue
perfects her interest in the equipment by proper filing. Sue's PMSI prevails over the
bankruptcy trustee's interest.
4.
2
HiAe ~ e I \ \ c . e seI\le etc.
Power over Fraudulent Transfer yeel\V's I I
a. The trustee also has power to set aside fraudulent transfers made I_I
within two years of the filing date.
1)ebtoV'
i\\solve\\t
b. A fraudulent transfer is any transfer made with intent to hinder, delay, or defraud
creditors or any transfer where the debtor received less than equivalent value
while the debtor was insolvent. (See Creditors' Rights outline for more details.)
EXAMPLE
A few days before filing a voluntary petition in bankruptcy and while Debtor was insolvent, Debtor
gave Friend a $5,000 cash gift. The gift can be set aside (recovered from Friend) as a fraudulent
transfer.
5. Trustee Can Disaffirm(Preferences) lfO AeI\ys/o\\e yeel\V'
The trustee has the power to set aside preferences. When the payment is "set aside,"
the payment is taken back from the creditor who received it and becomes part of the
bankruptcy estate.
Made within 90 days prior to the filing of the petition (one year if the
creditor is an insider, such as an officer of the debtor organization or a
close relative of the debtor);
On account of an antecedent debt of the debtor;
~ a .
A Preferential Payment is:
(1) A transfer made to or for the benefit of a creditor;
(2)
(3)
(4) Made while the debtor was insolvent; and
-
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Regulation 7
Becker Professional Education I CPA Exam Review
That results in the creditor receiving more than the creditor would have
received under the Bankruptcy Code.
PASS KEY
Preferential payment is one of the most heavily tested issues when it comes to bankruptcy
questions on the CPA Exam. Be sure to memorize the definition above and the explanations
above. Understanding this material is one of the keys to your success!
b. Purpose: Prevent One Creditor Being Preferred Over Others
The purpose of the preferential transfer rules is to prevent one creditor from
receiving an unfairly large repayment relative to other creditors. Improper intent
is not a requirement to classify a transfer as preferential.
EXAMPLE
A few days before Deanna, a retailer, filed her bankruptcy petition, she paid in full a two-year
unsecured installment loan owed to Carla, a creditor who had been very nice to Deanna.
Deanna's assets are such that other unsecured creditors will not be paid in full. The payment
to Carla can be set aside as a preference.
c. Transfer
A transfer includes not only the payment of money or the giving of property, but
also the giving of a security interest.
EXAMPLE
Same facts as above, but instead of Deanna paying Carla in full, Deanna gives Carla a security
interest in all of Deanna's inventory, which Carla perfects. Carla's interest can be set aside as a
preference.
d.
Antecedent (Preexisting) Debt <AcceleV'eI\T-l\\
A payment is a preference only if it is for an antecedenY(preexisting) debt. A
contemporaneous exchange for value is not a preference.
EXAMPLE
A few days before Deanna, a retailer, filed for bankruptcy, she received from Alex, a supplier,
six cases of goods to be put into Deanna's inventory. Deanna paid for the goods in full on their
arrival. There is no preference here; this is a contemporaneous exchange for value.
R7-26
e. Insolvency-Presumed During 90 Days Preceding Bankruptcy
The debtor is presumed to be insolvent during the 90 days immediately
preceding the date the bankruptcy petition is filed.
f. Receipt of Greater Share-Creditor Received More
A preference exists only if the creditor receives more than he would receive in a
bankruptcy distribution. Therefore, payment to a fully secured creditor is not a
preference, because the creditor would have received the collateral and been
paid in full anyway.
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(2)
(3)
(4)
g. Exceptions: Transfers that Cannot be Set Aside by Trustee
(1) Transfers in the Ordinary Course of Business
A transfer made to repay a debt that the debtor incurred in the ordinary
course of business is not a voidable preference.
~ r- E_X_A_M_P_L_E -----1
A regular monthly installment payment will not be set aside as a preference. Similarly,
payment of current utility bills or current lease payments do not constitute a
preference.
PMSI Perfected within 30 Days
A PMSI is not a voidable preference if it is perfected within 30 days after
the debtor receives possession of the collateral, though it may be invalid
under state law if not perfected within 20 days of the debtor's receiving
possession.
Consumer Payments under $600
The trustee may not avoid payments or transfers of property of less than
$600 by a debtor whose debts are primarily consumer debts.
Domestic Support Obligations
Bona fide payments for domestic support obligations (e.g., spousal support
or child support) are not voidable preferences.
F. (Claims)Against the Estate I WeI\\\t eI\ shel\V'e
Claims include all rights to payment from the debtor's estate.
g.
h.
i.
Becker Professional Education I CPA Exam Review
(3) SEC Must be Informed within 15 Days
The SEC must be notified of the issuance of securities under Regulation D
within 15 days after the first sale.
Requirements of Rule 504-$1 Million Limit
(1) To be exempt under rule 504 the issuance of securities may not exceed $1
million within a 12-month period.
(2) Rule 504 has no limitation on the number or type of purchasers.
(3) Rule 504 generally does not require any specific disclosure to investors
prior to the sale.
Requirements of Rule 505-$5 Million Limit
(1) To be exempt under rule 505 the issuance of securities may not exceed $5
million within a 12-month period.
Securities issued under rule 505 may be sold to any number of accredited
investors and 35 or fewer unaccredited investors. Note that an accredited
investor is one such as an institutional investor, a bank, a natural person
with at least $1 million in net worth or $200,000 in annual income, officers
or directors of the issuer, etc.
PASS KEY
The examiners often try to trick you with the 35 unaccredited investor limit. Watch for fact
patterns that state that Regulation D offerings cannot be made to more than 35 investors.
Such a choice is incorrect because generally there is no limit on the number of unaccredited
investors under rule 504. Moreover, the 35 investor limit under rules 505 and 506 (below)
applies only to unaccredited investors-there can be any number of accredited investors. Note
also that the limitation goes to the number of actual purchasers and not to the number of
offerees.
(3) If only accredited investors purchase, no disclosure is required. If there
are any unaccredited investors, all investors must be given at least an
annual report containing audited financial statements.
Requirements of Rule 50G-Unlimited Dollar Amount 'i.\\Vesi-ovs
(1) Under rule 506 there is no limit on the amount (dollar value) of stock that O\\ly
may be sold.
R7-44
(2)
i-o 5"05"
Securities issued under rule 506 may be sold to any number of accredited
investors and 35 or fewer unaccredited but sophisticated investors (i.e., the
issuer must reasonably believe the unaccredited investor has sufficient
knowledge and experience in financial matters to be capable of evaluating
the risks of the investment).
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(3) If only accredited investors purchase, no disclosure is required. If there
are any unaccredited investors, all investors must be given at least an
annual report containing audited financial statements.
--------------------------------
PASS KEY
The examiners ask very picky questions concerning rule 504, 505, and 506 offerings under
Regulation D. You should memorize the information given above, especially the information
concerning limitations on amounts and investors. Also remember that general solicitation
generally is prohibited under rules 504,505, and 506.
3.
It is key to recognize the differences between an action under Section 11 of the 1933 Act and under
rule lOb-S.
Section 11 of 1933 requires no proof of scienter, reliance or negligence. The plaintiff need only
show that he acquired the stock and suffered a loss, and that there was a material
misrepresentation or material omission of fact in the registration statement.
Rule 10b-S of the 1934 Act requires proof of both scienter and reliance. Plaintiff must show he
bought or sold the stock, suffered a loss, a material misrepresentation or material omission of
fact, scienter and reliance.
Proof of negligence is insufficient under rule 10b-S.
FVeI\lAA
Insider Trading under Rule 10b-5
Under rule 10b-5, it is illegal for a person to trade on the basis of "inside" information if
the person would breach a duty of trust owed to the issuer of the security or the
shareholders of the issuer.
a. Basically, inside information is any material, nonpublic information about the
security or the issuer.
b. Typically, a securities issuer's insiders, such as directors, officers, controlling
shareholders, and employees of the issuer will be held to owe a duty of trust and
confidence. But outsiders, such as an issuer's CPAs, attorneys, and even
printers may also be held to owe a duty of trust.
c. A private person injured by a violation of rule 10b-5 can bring an action against
the person violating the rule for any actual damages (not punitive damages) or
seeking rescission of the transaction. The SEC can impose fines and seek
criminal penalties. BlAi- Aoes "oi- pVOSeClAi-e
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R7-52
COMPARISON OF THE ANTI-FRAUD PROVISIONS OF THE '33 AND '34 ACTS
Elements of Proof
'33 Act (Sections 12 & 17) '34 Act (Section lOb)
Source of misleading statement
Must be in registration Can be any written or oral
or omission
statement statement or omission
Transactions covered
Issuance of a security Sale or purchase of a security
Securities covered
Securities covered by the Any securities, whether or not
registration statement publicly traded or registered
Plaintiffs
Any person acquiring the Any purchaser or seller of the
security; SEC security; SEC
Defendants
Every person who signed the Anyone responsible for the
registration statement false statement or omission, or
Experts (including
a duty of trust and confidence
accountants)
by so trading
Materiality
False statement or omission False statement or omission
must be material must be material
Loss
Must prove Must prove
Reliance
Need not prove Must prove
Causation
Need not prove Must prove
Scienter
Need not prove Must prove
Knowledge of false statement
Plaintiff cannot know of false Plaintiff cannot know of false
or omission
statement or omission statement or omission
Remedies
Rescission or monetary Rescission or monetary
damages (section 12); criminal damages
damages (section 17)
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CPA LEGAL LIABILITY
I. INTRODUCTION
CPA legal liability can arise in any of the following ways: breach of contract, commission of a tort
(e.g., negligence, fraud, or constructive fraud), or violation of a statute. "3"3 ov"34 Aci-s
II. BREACH OF CONTRACT
A. In General
If a CPA does not fulfill the terms of his engagement, the client can hold the CPA liable for
breach. Contract liability generally requires privity, so only a party to the contract can sue
under a contract theory.
B.
Damages Nel\lMeA
1. Where a CPA breaches the contract, the client or third party beneficiary is entitled to
recover compensatory damages (sufficient money to compensate for the contract not
having been performed).
2.
\\l"Aevs 3.
If the CPA's breach is material, the CPA cannot recover any payment.
Of course, all defenses that were mentioned in the contract outline apply to a contract
made by a CPA (e.g., client's failure to let the CPA see any accounting records is a
failure to cooperate and is a valid defense).
III. COMMISSION OF A(TORT) el\ci-
A. In General-Negligence, Fraud and Constructive Fraud
CPA liability can also arise from commission of a tort. Three torts are relevant: negligence,
constructive fraud (also called gross negligence), and fraud.
2) FeI\llL\ve i-o
pvopevly
sL\peVVlse/
VeVlew
The defendant owed a duty of care to the plaintiff;
Elements in General
To make out a case for negligence, the plaintiff must show:
a.
1.
Negligence OVAl"eI\VY IWgg,HII
As a general rule, a CPA owes a duty to his or her client not to perform work negligently. If
the CPA performs negligently, he or she can be held liable for damages.
B.
t) FeI\llL\ve i-o
wel\V" el\bOL\i-
\c."Ow" Ie
weel\\c."ess
b. The defendant breached that duty by failing to act with due care;
c. The breach caused plaintiffs injury; and
d. Damages.
Eve" "oi- "eI\lMeA"3vA Pel\vi-y
Poi-e"T-lel\ll e"Aevs/l"vesi-ovs
2. To Whom is the Duty Owed?
a. A CPA's duty to act with reasonable care generally runs only to
clients and, under the majority rule, to any person or limited
foreseeable{c1ass}of persons whom the CPA knows will be relying on the CPA's
work.
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b. A minority of states follows the Ultramares decision, which limits CPA liability
more narrowly to persons in privity of contract with the CPA (clients) and
IINeI\lMeAII intended third party beneficiaries.
c. It is a(defense)that the plaintiff is neither a client nor a person whom the CPA
knows will be relying on the audit. tw\elMbevs pL\bliC ov
E xAMP L E eveAH...ovs
(1) Alex is hired by Becky to perform an audit of her business's financial statements. Becky
explains to Alex that her bank is requiring the audit before it will give Becky a loan. Alex owes
both Becky and the bank a duty not to perform negligently, but no duty is owed to the bank's
customers because they will not be relying on the audit and are not a limited class. Thus, if
Alex performs negligently, Becky defaults, and the bank goes bankrupt, the bank's customers
cannot sue Alex for negligence.
(2) Ann is hired by Claire Corp to audit Claire's financial statements in connection with a public
offering of Claire's stock. Ann negligently misses a material misstatement of fact in the
financial reports and signs the registration statement. Phil purchases some Claire Corp stock
and suffers a loss because of the error. Phil cannot recover in negligence from Ann. Although
Phil was within a foreseeable class of persons who might rely on the audited financial
statements, the class is not sufficiently limited.
111III1
3. Breach-Failure to Act with Due Care
a. A breach occurs when the CPA fails to act with reasonable care.
d.
b. The standard of care owed by a CPA is to perform with the same skill and care
expected of ordinarily prudent CPAs under the circumstances.
The best evidence that a CPA has acted like a reasonably prudent CPA is that
the CPA followed applicable standards for the profession (e.g., followed GAAS in
an audit or followed GAAP with regard to financial statements).
Following GAAS or GAAP is not an absolute defense. On rare occasions
following GAAS or GAAP can make a report or the financial statements
misleading.
4. Causation
The damages must have been caused by the CPA's negligence (e.g., when the plaintiff
knows of the CPA's error in sufficient time to avoid damages the court will find no
causal connection between the negligence and the loss).
Fraud and Constructive Fraud (Gross Negligence) IIBeI\A
CPA liability can also arise through fraud or constructive fraud.
IM'I
-rOV+ #2 C.
""
' ..
" . .- .
3. Private Securities Litigation Reform Act
A CPA has certain duties when performing an audit of a company registered under the
1934 Securities Exchange Act.
a. Audit Requirements
Each audit required pursuant to the 1934 Act must include:
(1) Procedures designed to detect illegal acts that would have a direct and
material effect on the financial statement;
(2) Procedures designed to identify related party transactions that are material
to financial statements or otherwise require disclosure; and
(3) Procedures to evaluate whether there is substantial doubt about the ability
of the issuer to continue as a going concern during the next fiscal year.
b. Procedure upon Detection
(1) If the accountant detects information of illegal acts, she must determine the
effect of the illegal act on the issuer's financial statements and inform the
issuer's audit committee of the illegality.
(2) If the audit committee fails to take action with respect to the illegal act, or
the client has no audit committee, the auditor is to report the conclusions
directly to the client's board of directors.
c. Notification to SEC
(1) The issuer's board is to report to the SEC the receipt of any such notice
within one day after receiving it and must furnish the accountant with a
copy of the notice.
(2) If the CPA fails to receive a copy of the notice within one day, the CPA is to
furnish the SEC with a copy of the report within one day.
(3) The CPA may resign from the audit before notifying the SEC.
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d. Limit on Liability
An accountant is not liable in a private action for findings or conclusions made
pursuant to these rules.
e. Civil Liability
An accountant who willfully violates these requirements may be fined.
4. Sarbanes-Oxley Act
Under the Sarbanes-Oxley Act it is a crime:
a. To knowingly alter, destroy, falsify, etc., a document with the intent to impede a
federal investigation;
b. For auditors to fail to keep all workpapers related to a public company for at least
seven years; and
c. To defraud the public in connection with a registered security.
END OF ANCILLARY MATERIAL
B. Privileges
The rules of evidence protect information exchanged in certain confidential I'M@wl
relationships (e.g., attorney-client, doctor-patient) by granting an evidentiary
privilege-information exchanged within the scope of the relationship may not be disclosed as
evidence in court without the consent of the privilege holder.
1. Generally No Accountant-Client Privilege under Federal Law
a. Despite the confidential nature of a client's financial information, generally federal
law does not recognize an accountant-client privilege.
b. A CPA can be forced to disclose client information, including workpapers, if
subpoenaed and relevant to a federal court case.
2. Generally No State Privilege
a. Most states follow the federal view and do not grant a privilege for accountant-
client communications.
E"ceptlo\\ b.
When the privilege does exist, state courts and agencies have no power to force
a CPA to disclose confidential client information.
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~ c. Workpapers
1. Disclosure Generally Prohibited
a. Workpapers belong to the accountant (or accountant's firm) that prepares them,
not the client.
b. The accountant is prohibited from showing the workpapers to anyone without the
client's permission except for the following:
/Not tl,w\\eA ovev
The workpapers may be shown to a prospective purchaser of the CPA's
practice, as long as the prospective purchaser does not disclose the
confidential information;
An accountant must show the workpapers if they are subpoenaed and
relevant to a court case;
Workpapers must be turned over to a state CPA society voluntary quality
control review panel when requested;
(1 )
(3)
(2)
Be vevy
~ e I \ t M l l l e l \ V
(4) To defend a lawsuit brought by a client;
(5) Official investigation of the AICPA/state trial board; and
(6) GAAP/GAAS requires disclosure.
PASS KEY
Note that while a CPA may allow a prospective purchaser to review confidential workpapers, the CPA may not
turn over the workpapers to a purchaser without the client's permission.
R7-58
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AN elL LA RY MAT ER I A L (for Independent Review)
Regulation 7
ANTITRUST LAW
I. INTRODUCTION
The antitrust laws generally prohibit businesses from engaging in conduct that could stifle free
competition. They are based on the theory that free competition will force businesses to compete,
and to compete successfully businesses will have to offer better products at lower prices.
Congress passed the first antitrust statute in 1890, the Sherman Antitrust Act. Since then,
Congress has passed a number of other antitrust statutes, including the Clayton Act, the Robinson-
Patman Act, and the Federal Trade Commission Act.
II. SHERMAN ACT-PROHIBITS RESTRAINTS OF TRADE AND MONOPOLIES
Iling;.,;",.". I
The Sherman Act has two prominent sections. Section 1 prohibits contracts, combinations and
conspiracies that restrain trade. Section 2 prohibits monopolies and attempts to monopolize. The
Sherman Act only applies to activities that have a significant impact on interstate commerce.
A. Section 1-Restraints of Trade
1. Rule of Reason Test: Balance Anticompetitive and Competitive Effects
Section 1 only prohibits agreements that unreasonably restrain trade. I_I
Courts balance the anticompetitive and competitive effects of the restraint. ...
This standard is known as the rule of reason test. In applying the rule of reason test,
courts consider:
a.
b.
The nature of the business involved;
The defendant's position in the industry (e.g., market leader, middle of
the pack, minor player);
c. How the restraint will likely affect the industry; and
II
'
....
...
2.
d. The purported goal of the restraint (e.g., to achieve economies of scale vs. to
crush competition).
Per Se Violations-Inherently Illegal and Without Legal Justification
Certain categories of restraints are inherently illegal by their very nature and,
thus, are illegal per se.
a. Plaintiff need only show this type of restraint occurred; (s)he need not show that
the restraint limited competition.
b. Defendant may not defend by showing the restraint was reasonable.
Horizontal Restraints -Agreements Between Competitors 3.
a.
.::'
Horizontal restraints involve agreements between industry players that
are on the same marketing level (e.g., agreements between two competing
manufacturers or between two competing retailers).
b. Horizontal restraints are generally illegal per se.
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Horizontal price fixing (i.e., agreements among competitors to fix prices) is a per
se violation of the Sherman Act.
a.
Vertical Restraints-Agreements by Those at Different Marketing Levels
a. Vertical restraints are agreements between industry players that are on different
marketing levels (e.g., an agreement between a television manufacturer and a
retailer).
b. Vertical restraints are generally judged by the rule of reason test.
Concerted Action Requirement-Action by Two or More Parties
One business cannot violate Section 1 by itself-violation requires concerted action
between at least two parties.
a. A business can refuse to deal with whomever it likes, as long as it does so
independently.
b. An agreement between a corporation and a wholly owned subsidiary does not
violate the Sherman Act. They are viewed as one entity.
6. Price Fixing-Agreements to Set Prices for Goods or Services
4.
5.
I'Dnil,I;1
I-I
.I :_
In an exclusive dealing agreement, the seller of goods requires the
buyer to promise not to deal in goods of a competitor (e.g., a
furniture manufacturer prohibits retailers that carry its products from
carrying competing brands).
b. Such arrangements are treated more leniently than tying arrangements, but will
be held to violate the Clayton Act if they tend to create a monopoly or may
substantially lessen competition.
a.
C. Section 7-Mergers and Acquisitions
Section 7 of the Clayton Act prohibits the merger or acquisition of a company if the effect is to
substantially lessen competition. It allows the Department of Justice to proscribe mergers and
acquisitions in their incipiency, before they develop monopoly power.
1. Horizontal Mergers-Mergers Between Competitors
a. In determining if a horizontal merger violates the Clayton Act, courts
consider:
- (1) Market concentration (i.e., the number of competitors that share a market).
If a small number of companies share a large market, the market is
concentrated;
(2) The market share of the acquirer after the merger;
(3) The trend towards concentration in the market; and
(4) Whether the merger was designed to establish market power or restrict
competition.
b. Horizontal mergers are judged more stringently than other types.
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Vertical Mergers-Firm Acquires its Customers or Suppliers
2.
a.
b.
A forward vertical merger occurs when a firm acquires a customer.
A backward vertical merger occurs when a firm acquires a supplier.
a.
2.
D.
111II1
E.
R7-64
c. With vertical mergers courts focus almost exclusively on the likelihood that
competition may be foreclosed in a substantial share of the market.
3. Conglomerate Merger-Between Those in Different Businesses
In a conglomerate merger, a firm acquires a company in a completely different
business (i.e., a merger between firms that neither compete nor have a
customer/supplier relationship).
b. Conglomerate mergers have only been challenged when one of the merging
firms is highly likely to enter the market of the other or where the merged
company would become disproportionately large.
4. Failing Company Exception-Permissible if No Other Buyer
If the acquired firm is in danger of becoming insolvent and no other purchasers are
interested in acquiring it, a merger can be lawful even if the effect is to lessen
competition.
Section 8-lnterlocking Directorates
1. Section 8 of Clayton prohibits competing corporations engaged in interstate commerce
from having common directors (interlocking directorates).
a. Section 8 only prohibits interlocking directorates in competing firms.
b. Interlocking directorates in competing firms is permissible if the overlap in
competition is insignificant.
2. Section 8 does not apply to banks, banking associations, trust companies, and common
carriers.
Robinson-Patman Act
The Robinson-Patman Act of 1936 amended and strengthened section 2 of the Clayton Act
that prohibited price discrimination.
1. General Provisions
a. Section 2 of the Clayton and Robinson-Patman Acts only apply to price
discrimination of commodities of like grade and quality. They do not cover price
discrimination involving services, real estate or intangibles.
b. Robinson-Patman prohibits both sellers and buyers from price discrimination only
if it substantially lessens competition or tends to create a monopoly.
c. It prohibits buyers from inducing and sellers from granting discounts of any type
(e.g., allowances for advertisements, samples, special financing, etc.).
Types of Anticompetitive Effects
a. Primary-Line Injury-Injuries to a Seller's Competitors
(1) Price discrimination that causes injury to a seller's competitors are called
primary-line injuries.
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3.
(2) Plaintiff must prove intent to harm competition through predatory pricing or
show price discrimination actually harmed competition.
b. Secondary-Line Injury-Injuries to a Seller's Customers
(1) Robinson-Patman amended Clayton to protect small buyers I.. -I
from being harmed by discounts sellers gave to large buyers.
(2) Plaintiff must prove substantial and sustained price differences in a market
or show price discrimination actually harmed competition.
(3) Courts will infer harm to competition from a sustained and substantial price
difference between competing purchasers.
c. Tertiary-Line Injury-Injuries to Customers of a Seller's Customers
Tertiary-line injuries occur when a customer who is receiving a discriminatory
price passes the benefits on to its customers. I_I
Defenses to Price Discrimination
a. Cost Justification-Passing Cost Savings on to Customers
A seller may legally pass cost savings on to customers if the seller can prove it
costs less to sell the product. The discount must be given to aI/ buyers in that
group (e.g., quantity discounts for aI/large purchasers).
EXAMPLE
Acme manufactures television sets. Acme realizes substantial shipping cost savings for large
quantity purchases. Acme gives quantity discounts that reflect its savings to all large quantity
purchasers.
b. Changing Conditions-Temporary Conditions Affecting a Market
Price discrimination is permissible for temporary situations caused by the
physical nature of the goods (e.g., charging a cheaper price for deterioration of
perishable items, selling seasonal items out of season, forced judicial sales,
etc.).
c. Meeting Competition-But Cannot Price to Beat Competition
Price discrimination is permissible to meet, but not beat, an equally low price of a
competitor in a given area.
F. Enforcement of Clayton and Robinson-Patman
1. The Federal Trade Commission and the Department of Justice can enforce Clayton and
Robinson-Patman through civil actions, not criminal actions.
a. They may ask courts to order divestiture (i.e., ordering a firm to give up one or
more of its operating functions) or dissolution.
b. They may seek injunctions to prevent further violations.
c. They may issue cease and desist orders (i.e., an order to a firm to stop its
anticompetitive behavior).
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2.
Becker Professional Education I CPA Exam Review
Private parties harmed can sue for treble damages and attorney's fees.
a. Private parties must show they were directly harmed by the violations.
b. Firms participating in the anticompetitive behavior may not sue.
IV. FEDERAL TRADE COMMISSION ACT
In 1914 Congress passed the Federal Trade Commission Act and created the Federal Trade
Commission (FTC).
A. Prohibited Activities
1.
II
The Act makes illegal unfair methods of competition and is not confined to activities that
were prohibited under the Sherman or Clayton Acts. It also prohibits unfair or deceptive
practices.
a. To be "unfair" a method of competition or practice must be substantial, it must
not be outweighed by any countervailing benefits to consumers and it must be an
injury that consumers could not avoid.
b. To be "deceptive" there must be a misrepresentation, omission, or practice that is
likely to mislead a reasonably acting consumer.
2. The Act also prohibits advertisements without a reasonable basis for their claims.
B. Enforcement of the Act-No Private Party Suits Permitted
1. The FTC has the power to seek preliminary and permanent injunctions.
2. The FTC has the power to issue cease and desist orders.
3. The FTC can require advertisers to make affirmative disclosures (i.e., include
information so that the ad is not deceptive) and may also require corrective
advertisements (admit in advertisements that previous ads were deceptive).
4. The Act does not permit private party lawsuits for treble damages.
V. EXEMPTIONS FROM ANTITRUST LAWS
A. Statutory Exemptions from Antitrust Law
1. Labor unions are permitted to organize and bargain without violating antitrust law under
the Clayton Act.
2. Agricultural associations are also exempt from antitrust laws by Clayton.
3. The insurance business has a partial exemption.
4. American exporters may engage in joint export activities as long as the activities do not
restrain trade within the United States.
5. Cooperative research among small businesses is exempt.
B. Judicial Exemptions from Antitrust Law
1.
2.
Businesspersons may join together to obtain legislative or executive action.
Professional baseball is exempt from antitrust law.
END OF ANCILLARY MATERIAL
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AN elL LA RY MAT ER I A L (for Independent Review)
Regulation 7
COPYRIGHTS AND PATENTS
I. COPYRIGHTS
A. Introduction
A copyright is a federal right that gives authors of original works certain rights to control the
reproduction of the work.
B. What Works May Be Protected?
Copyright protection extends to original works of authorship in any tangible medium of
expression. The following is a nonexhaustive list of the types of work protected by copyright
law:
(i) Literary works, such as books;
(ii) Musical works (both lyrics and musical scores) and choreographic works;
(iii) Pictures, whether painted, drawn, photographed, etc.;
(iv) Films;
(v) Sculptures;
(vi) Computer programs (but it is generally agreed that the look of a user interface-such
as how Windows appears-is not protected by copyright);
(vii) Architectural works; and
(viii) Foreign language reproduction of a copyrighted work.
1. What Is Not Protected?
Procedures, processes, concepts, etc., are not protected by copyright. For example,
the script of the movie Pocahontas is protected by a copyright. But the idea of a young
girl attuned to nature befriending an alien, teaching him the ways of her people, and
having him be accepted by her tribe is not protected by copyright (hence we have the
movie Avatar).
C. What Are the Rights?
A copyright gives its owner the exclusive right to:
(i) Reproduce the work;
(ii) Prepare derivative works based off the work;
(iii) Distribute copies of the work (e.g., by selling it, licensing it, etc.); and
(iv) Perform or display the work publicly.
1. Limitation-Fair Use Doctrine
The fair use doctrine allows use of a copyrighted work without the owner's permission
for purposes of:
(i) Criticism and comments (e.g., movie or book reviews);
(ii) News reporting; and
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(iii) Teaching (including multiple copies for classroom use).
In determining whether the use of a copyrighted work is fair, the courts will consider a
number of factors, including the purpose of the use, the nature of the work, the amount
of the work that was used (e.g., the entire book, a chapter, a few sentences); and the
effect of the use on potential markets.
2. Rights Arise Automatically, But Must Register to Enforce Rights
Copyright protection is automatic. It arises as soon as an author/creator fixes his or
her work in a tangible medium of expression. However, to be able to enforce
copyrights in court, the copyright owner must generally register the copyright with the
federal Copyright Office.
D. Who Owns the Copyright?
Typically, the creator of a copyrighted work owns the copyright. Exceptions:
(i) If the work was created by an employee for his or her employer within the scope of
employment, the employer owns the work.
(ii) If someone commissioned the work to be created (work for hire-such as was done
with the text you are reading now) the person commissioning the work is the owner (in
the case of this book-Becker CPA).
1. Rights Transferable if In Writing
Ownership of a copyright may be transferred, but the transfer must be memorialized by
a writing signed by the copyright owner.
E. Protection
In a suit for copyright infringement, the copyright owner need only prove ownership and a
violation of one of the above rights.
(i) The owner does not have to prove fault (i.e., even an unintentional infringement is
actionable).
(ii) The owner does not have to prove that the entire work was taken; use of a substantial
part of the work can be sufficient.
1. Remedies
The following remedies are available:
(i) Injunction;
(ii) Impoundment of the offending material;
(iii) Damages, including profits made by the infringer or statutory damages of
between $500 and $20,000 (or $100,000 if the infringement was willful);
(iv) Costs of bringing the suit; and
(v) A criminal fine of up to $250,000 or five years imprisonment (the highest
penalties are available only for cases of large scale piracy of recordings or
movies under an amendment to the copyright laws known as the No Electronic
Theft Act or NETA); note that NETA does not require sale of the pirated material;
just large scale distribution.
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2. How Long do Rights Last?
A copyright owned by an individual last for the author's life plus 70 years. A copyright
owned by a company lasts for 95 years from the time it was first published or 120 years
from its creation, whichever is earlier.
II. PATENTS
A. What Works May Be Protected?
A patent is a federal right to protect an invention, process, or design that is: (i) novel; (ii)
useful; and (iii) not obvious to a person skilled in the area. Things that may be protected by
patents include:
(i) Machines;
(ii) Chemical compounds (such as drugs);
(iii) Plants produced by asexual reproduction;
(iv) Genetically engineered bacteria; and
(v) Computer programs.
1. What Is Not Protected?
Naturally occurring substances (e.g., plants), abstract ideas, laws of nature, and ideas
may not be patented. Neither may business methods, such as new accounting
techniques.
2. Must Apply to U.S. Patent and Trademark Office
Unlike copyright protection, patent protection is not automatic. It arises only upon
issuance of a patent by the U.S. Patent and Trademark Office (PTO). The application
for a patent must include design specifications that describe how the product works,
drawings, and an explanation of why it is patentable.
B. Who Owns the Patent?
Typically, the creator of the patented item owns the patent. Exceptions:
(i) If the work was created by an employee for his or her employer within the scope of
employment, the employee owns the patent but must use it for the employer's benefit
and must assign the right to the employer.
(ii) If the employee was not hired to create the patented product, but used the employer's
facilities to create the product, the employer has the shop right to nonexclusive use of
the patent without paying a royalty.
1. Rights Transferable if In Writing
Ownership of a patent is transferable, but the transfer must be memorialized by a
writing signed by the patent owner.
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c. Protection
If a patent is granted, the owner of the patent has the exclusive right to make, use and sell the
invention for which the patent was issued.
1. Remedies
The following remedies are available if another uses a patented design, product, or
process without the owner's permission:
(i) Injunction;
(ii) Damages at least equal to a reasonable royalty for using the patent; treble
damages if the unauthorized use was intentional; and
(iii) Attorneys' fees and costs of bringing the suit.
2. Possible Defense-Patent Improperly Granted
One possible defense to a patent infringement suit is that the patent should not have
been issued-that the product or design was not truly novel, useful, and nonobvious.
3. Lack of Knowledge is No Defense
Anyone who, without permission, uses or sells a patented invention is liable as a direct
infringer. Good faith and lack of knowledge are not valid defenses to direct
infringement.
4. How Long Do Rights Last?
A patent lasts for 20 years for most inventions; 14 years for design patents.
END OF ANCILLARY MATERIAL
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