2009 R-6 Class Notes

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Becker CPA Review Regulation 6 Class Notes

1 2009 DeVry/Becker Educational Development Corp. All rights reserved.

REGULATION 6 CLASS NOTES

This lecture covers commercial paper, secured transactions and real property. According to theAICPAs Content Specification Outline these items and the items found in R6 and R7 should make upbetween 20% and 25% of your Regulation examination.

COMMERCIAL PAPER

I. Terminology

A. There are four important steps to analyze for commercial paper:

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

2. Determine whether the instrument is negotiable.

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

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

B. Two Party Paper Notes a promise by the "maker" to pay money to the "payee," or

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

C. Three Party Paper Drafts "drawer" orders "drawee" to pay a third party. ChecksAlways payable "on demand" and the "drawee" must be a bank. Trade Acceptance special type of "draft" that is drawn by a seller ordering the buyer to pay. The buyer istypically the drawee and accepts the instrument for payment.

D. Demand vs. Time Instrument An instrument payable on "demand" is a demand note ordraft. An instrument payable at a future date is a time note or draft.

II. Negotiability (Step 2)

A. The front of the instrument determines the negotiability.

B. Must meet the technical requirements under the UCC.1. Be a writing.

2. Signed by the maker (note) or drawer (draft). The UCC is very liberal about thesigning requirement; it could be an X if the maker cannot write.

3. Contain an unconditional promise (note) or order (draft) to pay. If the payment is"conditional," the instrument is not negotiable.

4. Be for a fixed amount of money. Not money and/or goods or services. Money only.With interest (percentage stated or unstated) is okay.

5. Payment is on demand or at a definite time.

6. Payable to order or to bearer.

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

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

A. The instrument must be transferred in a proper way. This is called negotiation. The UCCprotects the "Holders in Due Course" (HDC).

B. Steps in becoming a holder. A holder is a person with good title to the commercial paper.

C. Bearer Paperrequires mere delivery. Order paperrequires delivery and endorsement.

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D. Last endorsement on the back of the instrument controls whether it is order or bearerpaper.

E. A Special endorsement names a specific party who must endorse for further transfer. ABlank endorsement does not name a new endorsee. A Qualified endorsement containsthe words "without recourse" and disclaims contract liability of the endorser. Restrictiveendorsements contain conditions.

F. "Breaking the Chain of Title" if a necessary endorsement is missing or forged, there is abreak in the chain of title and no subsequent transferee can become a holder.

G. Becoming an HDC you may have rights superior to the transferor. A holderwill takecommercial paper as an HDC to the extent he takes the paper:

1. For value

2. In good faith, and

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

H. The Shelter Doctrine - to assure free transferability of commercial paper the UCC providesthe most subsequent transferees of an HDC "take shelter in" the rights of the HDC. Atransferee takes whatever rights his or her transferor has. Therefore, even if the transferee

does not qualify as an HDC in his own right, he can claim the rights of an HDC who heldthe note before him.

IV. Claims and Defenses on the Instrument

A. REAL Defenses maker doesnt have to pay. The "FAIDS" mnemonic.

1. Fraud in the execution. Forgery of a necessary signature.

2. Adjudicated insanity. Material Alteration of the instrument.

3. Infancy. Illegality.

4. Duress. Discharge in bankruptcy.

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

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

V. Liability of the Parties

A. Maker = primarily liable.

B. Drawer = secondarily liable.

C. Drawee = primarily liable after acceptance.

D. Endorsers. Contract liability by signing the document secondary liability (liable ifinstrument is presented for payment, is dishonored, and endorser is given notice of

dishonor). Warranty liabilities made by anyone who transfers the instrument (only to theimmediate transferee if transferor does not endorse; to all subsequent transferees iftransferor endorses) transferors warrant that the transferor is entitled to enforce theinstrument; all signatures are genuine; the instrument has not been materially altered; nodefenses are good against the transferor; and the transferor has no knowledge of anyinsolvency proceedings.

E. Discharge Parties can be discharged from their liabilities

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

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2. By cancellation or renunciation.

3. By impairing recourse or collateral.

4. By delay in presentment,

5. By acceptance of a draft by a bank.

SECURED TRANSACTIONS

I. Introduction

A. Secured Transaction a debt secured by collateral.

B. Security interest allows creditor to take the property if debtor fails to pay obligation.

C. Effective between debtor and creditor upon attachment. Gives creditor the right to seizethe collateral upon the debtor's default.

D. Effective against third parties upon Perfection.

E. Purchase Money Security Interest (PMSI).

1. Special type of security interest that has priority over other types of security interestin the same collateral, if the PMSI is properly perfected.

2. Creditor sells assets to debtor on credit and retains a security interest in the asset(collateral) for the purchase price; or the creditor advances funds used by the debtorto purchase the collateral.

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

1. Consumer Goods Personal use.

2. Inventory (goods held for sale), and

3. Equipment (other goods used in business).

II. Creation (Attachment) of Security Interest

A. 3 requirements for attachment. (VAC)

1. Agreement (creates the security interest) evidenced by either an authenticated record(such as written security agreement or a computer file) or creditor taking possessionof the collateral.

2. Value must be given by the secured party.

3. Debtor must have rights in the collateral.

B. After-acquired property a security interest in property acquired by debtor in the future.

III. Perfection of the Security Interest

A. Perfection protects the creditor from third parties.

B. Timing of perfection Perfection cannot be complete until there is attachment.

C. Ways to perfect

1. Filing filing a financing statement

2. Possession not intangibles

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3. Control investment property

4. Automatic Perfection PMSI in Consumer Goods.

5. Temporary Perfection

a. Twenty-day period. A security interest in proceeds from original collateral iscontinuously perfected for 20 days.

b. Interstate shipments four month grace period. Collateral is taken from onestate to another; perfection in the first state is valid for four months in thesecond state.

IV. Priorities

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

B. Properly Perfected PMSI Second Place.

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

2. A second-hand buyer of consumer goods will take the goods free of an automaticallyperfected PMSI as long as the consumer had no notice (for example the PMSI holderdid not file a financing statement) of the security interest.

3. PMSI in inventory has priority over a prior perfected security interest in the sameinventory if the PMSI is perfected before the debtor gets possession of the collateraland the holders of other security interests in the collateral receive notice of the PMSIbefore the debtor receives the inventory.

4. A PMSI in noninventory collateral (e.g., equipment) has priority over conflictingsecurity interests in the same collateral as long as the PMSI is perfected within 20days after the debtor receives the collateral perfection relates back to the date thedebtor received possession.

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

conflict between perfected security interests the first to file or perfect wins. If there is aconflict between a perfected security interest and a judicial lien that has attached the firstto perfect, if security interest, or attach, if judicial lien, has priority.

D. Unperfected security interest fourth place. If two unperfected security interests then firstto attach.

E. Debtor last place.

V. Rights on Default

A. Creditor may take possession and sell.

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

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

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

E. Proceeds pay expenses of repossession and sale; then pay creditors in order of priority;and any surplus goes to the debtor.

F. Creditor may retain the collateral in satisfaction of the debt if the debtor is a consumer itwill be considered full satisfaction nonconsumer the secured party can still collect any

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deficiency secured party cannot retain the collateral if the debtor has paid at least 60%then creditor must sell.

REAL PROPERTY

I. Interests in real property

A. Joint Tenancy right of survivorship. Four unities Time, Title, Interest and Possession.

Severance transferee becomes a Tenant in Common.

B. Tenancy in Common no right of survivorship. Transferable by deed or will.

C. Tenancy by the Entirety joint tenancy between spouses. Similar to joint tenancy becauseit has right of survivorship.

LANDLORD AND TENANT

I. Types of Leaseholds

A. Leasehold estate entitles the tenant to exclusive possession of the land. Statute of Fraudsrequires a writing for leases of more than one year.

B. Tenancies for years fixed period of time; can be less than one year.

C. Periodic tenancies continue until terminated by notice.

D. Tenancies at will either party may terminate at any time no notice needed.

II. Assignments and Subleases

A. A landlord may assign or sell his interest in the property.

B. Unless expressly prohibited, a tenant may freely transfer his/her leasehold interest in wholeor in part.

C. Assignment is a complete transfer of the leasehold. The new tenant and the original tenantare both liable to the landlord.

D. Sublease is where a tenant retains a part of the remaining term. Only the original tenant isliable to the landlord the new tenant is liable to the original tenant only.

III. Warranties

A. The Landlord makes 3 implied warranties on the leasehold.

1. Warranty of Possession landlord will put the tenant in possession of the property atthe beginning of the lease.

2. Quiet Enjoyment neither the landlord nor someone with superior title will interferewith the tenant's quiet enjoyment of the premises.

3. Habitability the premises will be reasonably suitable for occupation.

B. Death of landlord or tenant does not generally end the lease.

C. Fixtures the landlord and tenant can agree to the treatment of fixtures but absent anagreement the courts will consider the intention of the party who placed the fixture and thedamage that would be caused by removal. Value is not considered.

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IV. Transfer of Real Property Conveyancing

A. Land Sale Contracts Statute of Frauds applies. In every sale the seller warrants they willprovide the buyer with marketable title.

B. Deeds Statue of Frauds applies. Deeds must be delivered to be effective.

C. Types of Deeds

1. General Warranty Deed Best protection. The grantor covenants against titledefects created by him and by all prior title holders.

2. Special Warranty Deed only two assurances - the grantor has not conveyed thesame estate to anyone else and the estate conveyed is free form encumbrances.

3. Bargain and Sale Deed The only warranty is that the grantor has title.

4. Quitclaim Deed-No warranties It releases whatever claim the grantor may have inthe property.

D. Recording requires a grantee to record a deed to give notice to third parties. Three typesof recording acts:

1. Notice Bonafide Purchaser without notice prevails over an unrecorded deed.

2. Race-notice/Notice-race Bonafide purchaser prevails if she records before theprior grantee records and has no notice of the prior transfer.

3. Race statutes First to record wins - notice is irrelevant.

V. Mortgages

A. Similar to Secured Transactions a debt secured by real estate. The collateral is realestate.

B. Statues of Frauds applies the mortgage must be in writing.

C. Mortgage must include the name of the grantor/mortgagor and grantee/mortgagee; wordsof grant; description of the property; mortgagor's signature; and the mortgagor's

acknowledgement.

D. Recording a mortgage has the effect similar to filing a financing statement, it gives themortgagee priority over other persons who might have an interest in the property. Uses thesame recording rules as deeds Notice, race-notice, and race statutes. As a general rule,the first mortgagee to obtain and record a mortgage will have priority over all subsequentmortgagees and purchasers.

E. Right of mortgagee on default of mortgagor To foreclose and sell. Depending on statelaw the creditor may be able to collect a deficiency (if the land sale proceeds are insufficientto cover the debt) from the debtor.

F. Right of redemption after default but before the foreclosure sale the debtor has the rightto redeem the property by paying the mortgagee in full. After the foreclosure sale, some

states provide an additional amount of time for the debtor to redeem the property typically6 months.

G. The foreclosure sale eliminates all junior interests in the property.

H. Proceeds for the judicial sale are distributed first to the foreclosing mortgagee to cover themortgage debt, interest due and the cost of foreclosure. Any remaining proceeds aredistributed to the junior lien holders in order of priority with any remaining balance gong tothe debtor.

I. Adverse Possession title by open and notorious trespass for a long period of time.

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There is REQUIRED HW READING on Suretyship, Creditors Rights, Documents of Title andLetters of Credit after the lecture text.

These are included and should be studied because they are within the scope of the ContentSpecifications released by the AICPA and could appear on your exam.

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