Sarah Nilsson JD, PhD, MAS
Sarah NilssonJD, PhD, MAS

BA 390 - Part B

10 - Contract Impediments - Key Concepts


Consideration: think 2-way street - there are 3 rules

1. both parties must get something of measurable value

2. promise to give something of value is consideration

3. the 2 parties must have bargained for what was exchanged and struck a deal

Value: Act or forbearnance

Act: do something you were not legally required to do in the first place

Forbearance: opposite of an act

Kim v. Son

Adequacy of consideration: courts seldom inquire - peppercorn rule


Noncompete agreement: one party agrees not to compete with another in a stated type of business

To be valid, an agreement not to compete must be ancillary to a legitimate bargain

When a noncompete agreement is ancillary to the sale of a business, it is enforceable if reasonable in time, geographic area, and scope of activity

A noncompete clause in an employment contract is generally reasonable - and enforceable - only to the extent necessary to protect:

1. trade secrets

2. confidential information, or

3. customer lists developed over an extended period

King v. Head Start Family Hair Salons, Inc.

Exculpatory Clause: contract provision that attempts to release one party from liability in the event  the other party is injured - generally unenforceable:

1. when it attempts to exclude an intentional tort or gross negligence 

2. when the affected activity is in the public interest, such as medical care, public transportation, or some essential service

3. when the parties have greatly unequal bargaining power

4. unless the clause is clearly written  and readily visible

Capacity: legal ability to enter into a contract (beware of minors and those with a mental impairment)

Minor: under 18 - can create only a voidable contract - may be cancelled by the party who lacks capacity

Disaffirm: to give notice of refusal to be bound by an agreement

Restitution: restoring an injured party to its original position

A minor who disaffirms a contract must return the consideration he has received, to the extent he is able

A person suffers from a mental impairment if, by reason of mental illness or defect, he is unable to understand the nature and consequences of the transaction - generally creates only a voidable contract

Intoxication: so intoxicated that he cannot understand the nature and consequences of the transaction - contract is voidable

Reality of Consent: 

Rescind: to cancel a contract

Fraud: intending to induce the other party to contract, knowing the words are false or uncertain that they are true - 3 parts:

1. defendant knew his statement was false OR he made it recklessly and without knowledge of whether it was false - opinions and "puffery" are NOT fraud (puffery: reasonable person would realize it is a sales pitch representing the exaggerated opinion of the seller - not fact)

2. false statement was material

3. injured party justifiably relied on the statement

Misrepresentation: statement that is factually wrong

In the case of fraud, the injured party generally has a choice of rescinding the contract or suing for damages or, in some cases, doing both - contract is voidable

Innocent misrepresentation: not intentional or reckless

Mistake: legal

Bilateral mistake: occurs when both parties negotiate based on the same factual error

If the parties contract based on an important factual error, the contract is voidable by the injured party

Conscious uncertainty: no rescission is permitted when one of the parties knows he is taking on a risk

Unilateral mistake: occurs when only one party negotiates based on a factual error

To rescind for unilateral mistake, a party must demonstrate that she entered the contract because of a basic factual error and that either:

1. enforcing the contract would be unconscionable OR

2. the nonmistaken party knew of the error

Unconscionable contract: contract that is shockingly one-sided and fundamentally unfair

Contracts in writing:

Statute of Frauds: (1677) requires certain contracts to be in writing - to provide a court with the best possible evidence of whether the parties intended to make a contract

Agreements that MUST be in writing:

- for any interest in land (house, mortgage, easement, leased apartment)

Exception: full performance by seller

Exception: part performance by buyer

- that cannot be performed within one year

- to pay the debt of another

- made by an executor of an estate

- made in consideration of marriage

- for the sale of goods worth $500 or more

Baker v. Daves

What the writing must contain:

- Must be signed by the defendant ("signed by the party to be charged") AND

- Must state with reasonable certainty the name of each party, the subject matter of the agreement, and all essential terms and promises

E-signatures are valid in all 50 states:

Uniform Electronic Transactions Act (UETA)

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11 - Conclusion to Contracts - Key Concepts


2 parties make contract: rights and responsibilities subject to rules above

Sometimes contract affects third party who had no role in forming agreement itself - 2 contracting parties may intend to benefit someone else - third party beneficiary

Other times: one of contracting parties may actually transfer his rights or responsibilities to a third party raising issues of assignment or delegation

Third Party Beneficiary: someone who is not a party to a contract but stands to benefit from it

Types of beneficiary:

Promisor: person who makes the promise that the third party beneficiary benefits from

Promisee: person to whom a promise is made

Intended beneficiary: person is intended beneficiary and may enforce a contract if parties intended her to benefit and if either:

1. enforcing the promise will satisfy a duty of the promisee to the beneficiary OR

2. the promisee intended to make a gift to the beneficiary

Creditor beneficiary: if the promisee is fulfilling some duty, the third-party beneficiary is a creditor beneficiary - most often the duty the promisee is fulfilling is a debt already owed to the beneficiary 

Donee beneficiary: if the promisee is making a gift, the third party is a donee beneficiary

Incidental beneficiary: so long as the third party is either a creditor or a donee beneficiary, she may enforce the contract - if she fails to qualify as a creditor or donee beneficiary then she is merely an incidental beneficiary and she may not enforce the deal 


Schauer v. Mandarin Gems of California, Inc.


Assignment and Delegation

Assignment: contracting party may transfer his rights under the contract

Assignor: person making an assignment

Assignee: person receiving an assignment

Obligor: person obligated to do something under a contract

Any contractual right may be assigned unless the assignment:

1. would substantially change the obligor's rights or duties under the contract

2. is forbidden by law or public policy OR

3. is validly precluded by the contract itself

Assignment is also prohibited when the obligor is agreeing to perform personal services

Once the assignment is made and the obligor notified, the assignee may enforce her contactual rights against the obligor

The obligor may generally raise all defenses against the assignee that she could have raised against the assignor

Delegation: contracting party may transfer her obligations (duties) under the contract

Delegator: person who gives his obligation under a contract to someone else

Delegatee: person who receives an obligation under a contract from someone else

An obligor may delegate his duties unless:

1. delegation would violate public policy

2. contract prohibits delegation OR

3. obligee has a substantial interest in personal performance by the obligor (when the work will test the character, skill, discretion, and good faith of the obligor, she may not delegate her job, e.g. artists, performers, lawyers, doctors, dentists)

Performance and Discharge

Rescind: to terminate a contract by mutual agreement

Strict performance: Courts disfavor - a party is generally not required to render strict performance unless the contract expressly demands it and such a demand is reasonable

Substantial performance: in a contract for services, a party that substantially performs its obligations will receive the full contract price, minus the value of any defects

Good faith: parties to a contract must carry out their obligations in good faith

Novation: the substitution of a new contract for an old one - the new agreement extinguishes the rights and obligations that were in effect under the old agreement


Brunswick Hills Racquet Club Inc. v. Route 18 Shopping Center Associates


Breach: when one party materially breaches a contract, the other party is discharged

Statute of limitations: (SOL) limits the time within which an injured party may file suit - SOL begins to run at the time of injury and will limit the time within which the injured party may file suit

Impossibility: true impossibility means that something has happened making it utterly impossible to do what the promisor said he would do - generally limited to 3 causes:

1. destruction of the subject matter

2. death of the promisor in a personal services contract

3. illegality


Remedies: methods courts use to compensate the injured party (most common is money damages)

Interest: legal right in something - 4 principal contract interests a court may seek to protect:

1. Expectation interest: what the injured party reasonably thought she would get from the contract - designed to put the injured party in the position she would have been in had both sides performed their obligations - to win expectation damages, the injured party must prove the breach  of contract caused damages that can be quantified with reasonable certainty otherwise the plaintiff must ask for reliance damages

2. Reliance interest: the injured party may be unable to demonstrate expectation damages but may still prove that he expended money in reliance on the agreement - designed to put the injured party in the position he would have been had the parties never entered into a contract

3. Restitution interest: an injured party may only be able to demonstrate that she has conferred a benefit on the other party - here the objective is to restore to the injured party the benefit she has provided

Rescission: the undoing of a contract, which puts both parties in the positions they were in when they made the agreement

4. Equitable interest: when something more than money is needed - specific performance (e.g. order to transfer property to injured party) or injunction (order forcing one party to stop doing something)


Hawkins v. McGee


Compensatory (direct) damages: those that flow directly from the contract - most common monetary award for expectation interest

Consequential (special) damages: result from the unique circumstances of the plaintiff - only available if they are a foreseeable consequence of the breach

Incidental damages: relatively minor costs that the injured party suffers when responding to the breach


Bi-Economy Market, Inc. v. Harleysville Ins. Co. of New York


Specific performance: compels parties to perform the contract they agreed to when the contract concerns the sale of land or some other unique aspect

injunction: court order to d osomething or to refrain from doing something

Mitigate: to keep damages as low as possible - a party injured by a breach of contract may not recover for damages that he could have avoided with reasonable efforts

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12 - Practical Contracts - Key Concepts


Ignoring the role of a written agreement can lead to serious trouble

Oral contracts can certainly be successful, but there are times  when you should definitely sign an agreement:

1. The Statute of Frauds requires it

2. The deal is crucial to your life or the life of your business

3. The terms are complex

4. You do not have an ongoing relationship with the other party


Lawyers have a different perspective than businesspeople - their primary goal is to protect their clients by avoiding litigation, now and in the future

Lawyers also prefer to negotiate touchy subjects at the beginning of a relationship, when everyone is on friendly terms and eager to make a deal, rather than waiting until trouble strikes


The Contract:

- typically the party with the most bargaining power prepares the drafts

- mistakes: vagueness is your enemy

Quake Construction, Inc. v. American Airlines, Inc.

the true test of whether a vague clause belongs in a contract is this: Would you sign the contract if you knew that the other side's interpretation would prevail in litigation?

vagueness occurs when the parties do not want the contract to be clear - ambiguity is different - it means that the provision is accidentally unclear

any ambiguity is interpreted against the drafter of the contract because the rule is meant to:

1. protect laypeople from the dangers of form contracts that they have little power to change

2. protect people who are unlikely to be represented by a lawyer

3. encourage those who prepare contracts to do so carefully

typos: scrivener's error: a court will reform a contract if there is clear and convincing evidence that the mistake does not reflect the true intent of the parties

Heritage Technologies, LLC v. Phibro-Tech, Inc 


Structure of a contract

- title: as descriptive as possible

- introductory paragraph: date, names of parties, nature of contract

- covenants: promise in a contract about what the parties will do in a contract

- breach: to constitute a violation of the contract, the breach must be material

material breach: violation of a contract that defeats an essential purpose of the agreement

good faith: an honest effort to meet both the spirit and letter of a contract

sole discretion: party to a contract has the absolute right to make a decision on that issue

reasonable: ordinary or usual under the circumstances

reciprocal promises: promises that are each enforceable independently

conditional promises: promises that a party agrees to perform only if the other side has first done what it promised

- representations and warranties: statements of fact about the past or present

covenants are promises the parties make about what they will do in the future

- boilerplate: comes from iron or steel that protects the hull of a ship

choice of law provisions: determine which state's laws will be used to interpret the contract

choice of forum provisions: determines the state in which any litigation would take place

assignment of rights: transfer of benefits under a contract to another person

delegation of duties: transfer of obligations in a contract



attorney's fees: parties must pay their own legal fees



force majeure event: disruptive, unexpected occurrence for which neither party is to blame that prevents one or both parties from complying with a contract



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13 - Sales and Product Liability - Key Concepts



middle of 20th century - contract law required reinvention - 2 problems

1. old contract law principles often did not reflect modern business practices

2. laws had become different from one state to another

UCC was created as attempt to solve these 2 problems - proposal written by legal scholars at American Law Institute (ALI) and National Conference of Commissioners on Uniform State Laws

over time, lawmakers in all 50 states adopted many parts of UCC

Article 2 of the UCC applies to sale of goods

good: any moveable physical object except for money and securities

merchants: someone who routinely deals in the particular goods involved

UCC 2-104: merchant is someone who routinely deals in the particular goods involved, or who appears to have special knowledge or skill in those goods, or who uses agents with special knowledge or skill in those goods

The UCC frequently holds a merchant to a higher standard of conduct than a non-merchant


Contract Formation

UCC 2-204: 3 important rules that enable parties to make a contract quickly and informally

1. Any manner that shows agreement

2. Moment of making is not critical

3. One or more terms may be left open - under the UCC a court may enforce a bargain even though one or more terms were left open


Jannusch v. Naffziger  


Statute of Frauds

UCC 2-201 requires a writing for any sale of goods worth $500 or more - writing sufficient to indicate that the parties made a contract - simple memo is enough or letter or informal note mentioning that 2 sides reached an agreement - writing must be signed by the defendant

Enforceable only to quantity stated in the writing

Merchant exception: when 2 merchants make an oral contract, and one sends a confirming memo to the other within a reasonable time, and the memo is sufficiently definite that it could be enforced against the sender herself, then the memo is also valid against the merchant who receives it unless he objects within 10 days


Added terms - UCC 2-207 - battles of the form

An acceptance that adds or alters terms will often create a contract 

Additional terms: raise issues not covered in the offer - when both parties are merchants, additional terms generally become part of the bargain

Different terms: contradict those in the offer - cancel each other out - Code then supplies its own terms, called gap-fillers

Gap-fillers: UCC rules for supplying missing terms

Performance and Remedies

Buyer's remedies: 

a seller is expected to deliver what the buyer ordered

Conforming goods: satisfy the contract terms

Nonconforming goods do not

a buyer has the right to inspect the goods before paying or accepting and may reject nonconforming goods by notifying the seller within a reasonable time

seller has the right to cure - by delivering conforming goods before the contract deadline

Cover: if the seller breaches the buyer may cover by reasonably obtaining substitute goods; it may then obtain the difference between the contract price and its cover price, plus incidental and consequential damages, minus expenses saved

an injured buyer is generally entitled to incidental and consequential damages

incidental damages: cover such costs as advertising for replacements, sending buyers to obtain new goods, and shipping the replacement goods

consequential damages: result form the unique circumstances of the injured party - much more extensive and may include lost profits

a buyer expecting to resell goods may obtain the loss of profit caused by the seller's failure to deliver

Seller's remedies: 

seller may refuse to deliver the goods

if buyer unjustly refuses to accept ot pay for goods, seller may resell them - if resale is commerically reasonable the seller may recover the difference between the resale price and contract price plus incidental damages minus expenses saved

seller may sue for contract price


Warranties and Product Liability

product liability - injured party's remedies may be derived from several legal ideas including:

- warranty: assurance provided in a sales contract

- negligence: unreasonable conduct by the defendant

- strict liability: prohibits defective products whether or not the defendant acted reasonably 

Warranty: guarantee (contractual assurance) that goods will meet certain standards

Express warranty: guarantee, created by the words or actions of the selle, that goods will meet certain standards


Keller v. Inland metals All Weather Conditioning, Inc


Implied warranty: guarantees created by the UCC and imposed on the seller of goods

Implied Warranty of Merchantability: Goods must be of at least average, passable quality in the trade - unless excluded or modified a warranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind

merchantable: goods are fit for the ordinary purposes for which they are used - includes:

1. unless excluded or modified - seller may disclaim this warranty but must mention the word "merchantability"

2. merchantability - goods must be fit for their normal purposes

3. implied - law itself imposes this liability on seller

4. merchant with respect to goods of that kind - someone who routinely deals in these goods or holds himself out as having special knowledge about these goods


Goodman v. Wenco Foods, Inc


Implied Warranty of Fitness for a Particular Purpose: where the seller at the time of contracting knows about a particular purpose for which the buyer wants the goods and knows that the buyer is relying on the seller's skill or judgment there is (unless excluded or modified) an implied warranty that the goods shall be fit for such purpose 

Disclaimer: statement that a particular warranty does not apply - seller may disclaim all warranties by conspicuously stating that goods are sold "as is" or "with all faults" - exceptions: written express warranties generally cannot be disclaimed - and many states prohibit disclaimers in sale of consumer goods


CCB Ohio, LLC v. Chemque, Inc


Negligence - concerning sale of goods - plaintiff  most often raise one or more of these claims:

1. negligent design: designed poorly - product must be free of unreasonable risks

2. negligent manufacture: failure to inspect or sloppy conduct at plant

3. failure to warn: about dangers of normal use and also foreseeable misuse


Strict liability: injured person need not prove that the defendant's conduct was unreasonable

1. one who sells any product in a defective condition unreasonably dangerous to user or consumer or to his property is subject to liability for physical harm thereby caused to the ultimate user or consumer or to his property if 

- seller is engaged in the business of selling such a product AND

- it is expected to and does reach the user or consumer  without substantial change in the condition in which it is sold

2. the rule applies although

- seller has exercised all possible care in the preparation and sale of his product AND

- user or consumer has not bought the product from or entered into any contractual relation with the seller (privity not required)


Contemporary trends: 

- consumer expectation

- risk-utility test: value of product - gravity or seriousness of danger - likelihood that such danger will occur - mechanical feasibility of a safer design - adverse consequences of an alternative design

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14 - Negotiable Instruments - Key Concepts


Commercial Paper: system for transferring funds easily - 2 kinds - negotiable and non-negotiable

- UCC Article 3 governs only negotiable instruments while non-negotiable are governed by common law

Types of negotiable instruments

2 kinds - notes and drafts

Promissory note: the maker of the instrument promises to pay a specific amount of money

Maker: the issuer of a promissory note

Payee: someone who is owed money under the terms of an instrument

Draft: the drawer of this instrument orders someone else to pay money

Check: an instrument in which the drawer orders the drawee bank to pay money to the payee

Drawer: the person who issues a draft

Drawee: the person who pays a draft - in the case of a check the bank is the drawee

Issuer: the maker of a promissory note or the drawer of a draft

The fundamental rule of Commercial Paper

The possessor of a piece of commercial paper has an unconditional right to be paid, so long as

1. the paper is negotiable

2. it has been negotiated to the possessor 

3. the possessor is a holder in due course AND

4. the issuer cannot claim a valid defense

Holder in Due Course: someone who has given value for an instrument, in good faith, without notice of outstanding claims or other defenses

To work as a substitute for money, commercial paper must be freely transferable in the marketplace, just as money is - ie. it must be negotiable

The possessor of non-negotiable commercial paper has the same rights - no more no less - as the person who made the original contract (conditional)

The possessor of negotiable commercial paper has more rights than the person who made the original contract (unconditional)

To be negotiable:

1. the instrument must be in writing

2. the instrument must be signed by the maker or drawer

3. the instrument must contain an unconditional promise or order to pay 

4. the instrument must state a definite amount of money which is clear "within its four corners"

5. the instrument must be payable on demand or at a definite time 

6. the instrument must be payable to order or to bearer

Order paper: an instrument that includes the words "pay to the order of" or their equivalent

Bearer paper: an instrument payable "to bearer"

Interpretation of ambiguities 

when the terms in a negotiable instrument contradict each other - 3 rules apply

1. words take precedence over numbers

2. handwritten terms prevail over typed and printed terms

3. typed terms win over printed terms


Blasco v. Money Services Center


Negotiation: an instrument has been transferred to the holder by someone other than the issuer

Indorsement: the signature of the payee

To be negotiated, order paper must first be indorsed and then delivered to the transferee

Bearer paper must simply be delivered to the transferee - no indorsement required

A holder in due course has an automatic right to receive payment for a negotiable instrument (unless the issuer can claim a valid defense) 

Requirements for being a holder in due course

A holder in due course is a holder who has given value for the instrument, in good faith, without notice of outstanding claims or defects

Holder: for order paper, anyone in possession of the instrument if it is payable to or indorsed to her - for bearer paper, anyone in possession

Value: the holder has already done something in exchange for the instrument

Good faith: 2 tests and holder must meet BOTH

1. subjective test: did holder believe the transaction was honest in fact

2. objective test: did transaction appear to be commercially reasonable


Buckeye Check Cashing, Inc. v. Camp


Notice of outstanding claims or other defects

in certain circumstances a holder is on notice that an instrument has an outstanding claim or other defect:

1. the instrument is overdue (check overdue after 90 days) (other demand instrument overdue either day after a request for payment is made or reasonable time after instrument issued

2. the instrument is dishonored

3. the instrument is altered, forged, or incomplete

4. the holder has notice of certain claims or disputes 


Defenses against a holder in due course

the issuer of a negotiable instrument is not required to pay if:

1. his signature on the instrument was forged

2. after signing the instrument his debts were discharged in bankruptcy

3. he was underage (typically younger than 18) at the time he signed the instrument

4. the amount of the instrument was altered after he signed it (however if he left it blank he is liable)

5. he signed the instrument under duress, while mentally incapacitated, or as part of an illegal transaction

6. he was tricked into signing the instrument without knowing what it was and without any reasonable way to find out 

Consumer credit contract: a contract in which a consumer borrows money from a lender to purchase goods and services from a seller who is affiliated with the lender

Federal Trade Commission (FTC) has special rules for consumer credit contracts - requires all promissory notes on consumer credit contracts to contain language preventing any subsequent holder from being a holder in due course


Antuna v. Nescor, Inc.

Presentment Warranty

When used in relation to negotiable instruments, presentment warranty refers to an implied promise as to the title and credibility of an instrument made by a payer or acceptor upon the presentment of the instrument for payment. In the U.S., presentment warranty is expressly dealt under the Uniform Commercial Code. Pursuant to U.C.C. § 3-417 (a), if an unaccepted draft is presented to the drawee for payment or acceptance and the drawee pays or accepts the draft, (i) the person obtaining payment or acceptance, at the time of presentment, and (ii) a previous transferor of the draft, at the time of transfer, warrant to the drawee making payment or accepting the draft in good faith that:

(1) the warrantor is, or was, at the time the warrantor transferred the draft, a person entitled to enforce the draft or authorized to obtain payment or acceptance of the draft on behalf of a person entitled to enforce the draft; 

(2) the draft has not been altered; 

(3) the warrantor has no knowledge that the signature of the drawer of the draft is unauthorized; and

(4) with respect to any remotely-created consumer item, that the person on whose account the item is drawn authorized the issuance of the item in the amount for which the item is drawn.

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15 - Secured Transactions - Key Concepts


UCC Article 9 governs secured transactions in personal property

Fixtures: goods that have become attached to real estate

Security interest: an interest in personal property or fixtures that secures the performance of an obligation

Secured party: a person or company that holds a security interest

Collateral: property that is subject to a security interest

Debtor: a person who has original ownership interest in the collateral

Security agreement: a contract in which the debtor gives a security interest to the secured party

Perfection: a series of steps the secured party must take to protect its rights in the collateral against people other than the debtor

Financing statement: a document that the secured party files to give the general public notice that it has a secured interest in the collateral

Record: information written on paper or stored in an electronic or other medium

Authenticate: to sign a document or to use any symbol or encryption method that identifies the person and clearly indicates she is adopting the record as her own


Types of collateral

1. Goods - things that are moveable

2. Inventory - goods held by someone for sale or lease

3. Instruments - drafts, checks, certificates of deposit, notes

4. Investment property - securities and related rights

5. Other property - documents of title, accounts, general intangibles (copyrights, patents etc)


Attachment of a Security Interest

a 3-step process that creates an enforceable security interest

1. the 2 parties made a security agreement and either the debtor has authenticated a security agreement describing the collateral or the secured party has obtained possession

2. the secured party has given value to obtain the security agreement AND

3. the debtor has rights in the collateral





Debtor rights in the collateral

After-acquired property: items that the debtor obtains after the parties have made their security agreement (attachment to future property)



Several kinds:

1. perfection by filing - with the appropriate state agency - names of all parties - describes the collateral - outlines the security interest - enables any interested person to learn about it

A financing statement is sufficient if it provides the name of the debtor, the name of the secured party, and an indication of the collateral - name on financing statement must be the same as that in the person's driver's license, if one exists - once a financing statement has been filed, it is effective for 5 years (except manufactured home = 30 years) - renew within last 6 months prior to expiration

Corona Fruits and Veggies, Inc. v. Frozsun Foods, Inc.

2. perfection by possession - imposes one important duty - secured party must use reasonable care in the custody and preservation of collateral in her possession

3. perfection of consumer goods - UCC gives special treatment to security interests in most consumer goods

Consumer goods: those used primarily for personal, family or household purposes

Purchase money security interest (PMSI): an interest taken by the person who sells the collateral or advances money so the debtor can buy it - A PMSI in consumer goods oerfects automatically, without filing


Protection of buyers

Buyer in ordinary course of business (BIOC): someone who buys goods in good faith from a seller who routinely deals in such goods

Conseco Finance Servicing Corp. v. Lee

Priorities among creditors

when 2 creditors have a security interest in the same collateral - the one with priority gets it

3 rules:

1. a party with a perfected security interest takes priority over a party with an unperfected interest

2. if neither secured party has perfected, the first interest to attach gets priority

3. between perfected security interests, the first to file or perfect wins


In re Roser


Default and Termination

Default: generally a debtor defaults when he fails to make payments due or enters bankruptcy proceedings

secured party has 2 principal options:

1. it may take possession of the collateral (provided without breach of peace) OR

2. it may file suit against the debtor for the money owed

(secured party may try both options simultaneously)

Once secured party has obtained possession it has 2 choices:

1. dispose of collateral OR

2. retain the collateral as full satisfaction of the debt

Termination: once debtor pays full debt secured party must complete a termination statement - document indicating that it no longer claims a security interest in the collateral

CHAPTER 15 test bank student.docx
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16 - Bankruptcy - Key Concepts


Bankruptcy laws are controversial - American laws are more lenient towards the bankrupt

Bankrupt: aka debtor - someone who cannot pay his debts and files for protection under the bankruptcy code

The US Bankruptcy Code (the Code) has 3 primary goals:

1. To preserve as much of the debtor's property as possible

2. To divide the debtor's assets fairly between the debtor and creditors AND

3. To divide the creditor's share of the assets fairly among them


Chapter 7 - Liquidation - the bankrupt's assets are sold to pay creditors - if debtor owns a business, it terminates - creditors have no right to debtor's future earnings - aka straight bankruptcy: mandates that bankrupt's assets be sold to pay creditors but the bankrupt has no obligation to share future earnings

Chapter 11 - Reorganization - designed for businesses and wealthy individuals - businesses continue to operate and creditors receive a portion of both current assets and future earnings - (goal is to rehabilitate the debtor)

Chapter 13 - Consumer reorganization (individuals) - offers reorganization for the typical consumer - creditors usually receive a portion of the individual's current assets and future earnings - (goal is to rehabilitate the debtor)

Chapter 7 Liquidation

- Filing a petition: any individual, partnership, corporation, or other business organization that lives, conducts business, or owns property in the US can under the Code - filed in federal district court - not necessary that debtor's liabilities exceed assets

Voluntary petition: debtors go willingly

Individuals MUST meet 2 requirements before filing:

1. within 180 days before the filing, an individual debtor must undergo credit counseling with an approved agency

2. individual debtors may file under Chapter 7 only if they earn less than the median income in their state OR they cannot afford to pay back at least $7,025 over 5 years   

Voluntary petition MUST include:

- petition: begins the case - easy to fill out - requires checking a few boxes and typing in name, address, and social security number

- list of creditors: names and addresses of all creditors

- schedule of assets and liabilities: list of debtor's assets and debts

- claim of exemptions: list of all assets that the debtor is entitled to keep

- schedule of income and expenditures: debtor's job, income, and expenses

- statement of financial affairs: summary of the debtor's financial history and current financial condition - in particular the debtor must list any recent payments to creditors and any other property held by someone else for the debtor

Involuntary petition: creditors may drag debtors into court

Involuntary petition MUST meet all these:

- debtor must owe at least $14,425 in unsecured claims to the creditors who file

- if debtor has at least 12 creditors, 3 or more must sign the petition

- if debtor has fewer than 12 creditors, any of them may file a petition

- creditors must allege either that a custodian for the debtor's property has been appointed in the prior 120 days or that the debtor has generally not been paying debts that are due

custodian for the debtor's property: somes state law permits appointment of custodian to protect debtor's assets

order for relief: official acknowledgement that the debtor is under the jurisdiction of the bankruptcy court

Trustee: responsible for gathering the bankrupt's assets and dividing them among creditors - creditors have the right to elect a trustee

US Trustee: oversees the administration of bankruptcy law in a region - US Attorney General appoints a US Trustee for each region of the country to administer the bankruptcy law

Creditors: after order of relief the US Trustee calls a meeting of all the creditors - bankrupt MUST answer under oath any questions about financial situation - after this meeting, unsecured creditors must submit a proof of claim

Proof of claim: form stating the name of an unsecured creditor and the amount of the claim against the debtor

Automatic stay: prohibits creditors from collecting debts that the bankrupt incurred before the petition was filed

Jackson v. Holiday Furniture

Bankruptcy Estate: the new legal entity created when a debtor files a bankruptcy petition - all of the debtor's existing assets pass into the estate except exempt property and new property that debtor acquires after petition is filed

Exempt property: the Code permits individual debtors (but not organizations) to keep some property for themselves - saves debtor from destitution during bankruptcy process - provides foundation for a new life once process is over - here Code defers to state law - debtor can take advantage of this if they have lived in that state for 2 years prior to bankruptcy - under the federal Code debtor is allowed to exempt only $21,625 of value of her home - many states exempt debtor's home, household goods, cars, work tools, disability and pension benefits, alimony and health aids

Voidable preferences: the trustee can void any transfer to a creditor that took place in the 90-day period before the filing of a petition

Preference: when a debtor unfairly pays creditors immediately before filing a bankruptcy petition

Fraudulent transfers: if transfer is made within the year before a petition is filed and its purpose is to hinder, delay, or defraud creditors

Payment of Claims: The Code has adopted a number system to prevent a free-for-all fight over the bankrupt's assets - one of Code's primary goals is to ensure that creditors are paid in the proper order not according to who pushes to the front of the line - all claims are placed in one of 3 classes: 

1. secured claims

2. priority claims

3. unsecured claims

The trustee pays the bankruptcy estate to the various classes of claims in order of rank

A higher class is paid in full before the next class receives any payment at all 

Debtor is entitled to any funds remaining after all claims have been paid

Secured claims: creditors whose loans are secured by specific collateral are paid first - they are paid not out of general funds of estate but by selling a specific asset

Priority claims: each category of priority claims is paid in order with the first group receiving full payment before the next group receives anything - include:

1. Alimony and child support

2. Administrative expenses - fees to trustee - lawyers - accountants

3. Back wages  to debtor's employees for work performed during the 180 days prior to date of petition 

4. Income and property taxes

Unsecured claims: if assets remain


Discharge: once a bankruptcy estate has been distributed to creditors they cannot make a claim against the debtor for money owed before the filing whether or not they actually received any payment - these prepetition debts are discharged - the bankrupt no longer has an obligation to pay a debt - debtor must complete a course on financial management before receiving a discharge

Fresh start: after the termination of a bankruptcy case creditors cannot make a claim against the debtor for money owed before the initial bankruptcy petition was filed

Debts that cannot be discharged: debtor remains liable in full until they are paid

- recent income and property taxes

- money obtained by fraud

- cash advances on a credit card totaling more than $875 that an individual debtor takes out within 70 days before the order of relief

- debts omitted from the Schedule of Assets and Liabilities

- money owed for alimony, maintenance or child support

- debts stemming from intentional and malicious injury

- debts that result from a violation of securities laws

- student loans (unless repayment would cause undue hardship to the debtor)

Circumstances that prevent debts from being discharged

- Business organizations: under Chapter 7 only the debts of individuals can be discharged (not businesses) - once assets have been distributed organization must cease operation - if company resumes business again it becomes responsible for all its prefiling debts

- Revocation: court can revoke a discharge within 1 year if it discovers the debtor engaged in fraud or concealment

- Dishonesty or bad-faith behavior: court may deny discharge altogether if the debtor has made fraudulent transfers, hidden assets, or otherwise acted in bad faith

- Repeated filings for bankruptcy: debtor who has received a discharge under Chapter 7 or 11 cannot receive another discharge under Chapter 7 for at least 8 years after prior filing - debtor who received a prior discharge under Chapter 13 cannot receive a discharge for at least 6 years



Reaffirm: to promise to pay a debt even after it is discharged

Sometimes debtors are willing to reaffirm a debt, meaning they promise to pay even after discharge - they may want to reaffirm a secured debt to avoid losing the collateral


In re: Grisham


Chapter 11 Reorganization

for a business chapter 11's goal is resuscitating a business so that it can ultimately emerge as a viable economic concern - does not require them to dissolve

- debtor in possession: chapter 11 requires NO trustee - the bankrupt is called debtor in possession - has 2 jobs: 

1. to operate the business 

2. to develop a plan of reorganization

- creditors' committee: important because there is no trustee to watch over committee's interests - the US Trustee typically appoints the 7 largest unsecured creditors to the committee

- plan of reorganization: for the first 120 days after the order for relief the debtor has the exclusive right to propose a plan - if the shareholders and creditors accept it then the bankruptcy case terminates - if creditors or shareholders reject the debtor's plan they may file their own version

- confirmation of the plan: all the creditors and shareholders have the right to vote on the plan of organization - each are assigned to a class - secured claims - priority claims - unsecured claims

The bankruptcy court will approve a plan if a majority of each class votes in favor of it AND if the "yes" votes hold at least 2/3 of the total debt in that class

Even if some classes vote against the plan court can still confirm it under cramdown - if court rejects plan of reorganization creditors must develop a new one

- discharge: confirmed plan of reorganization is binding on debtor and creditors - debtor now owns the assets in the bankrupt estate free of all obligations except those listed in the plan

- small business bankruptcy: Congress decided to speed up the bankruptcy process for businesses with less than $2 million in debt - after order of relief the bankrupt has the exclusive right to file a plan for 180 days - court must accept or reject the plan within 45 days after its filing - if deadlines not met case may be converted to Chapter 7 or dismissed


Chapter 13 consumer Reorganizations 

To rehabilitate an individual debtor

Not available at all to businesses or to individuals with more than $360, 475 in unsecured debts or $1,081,400 in secured debts 

Bankrupt consumer typically keeps most of her assets in exchange for a promise to repay some of her debts using future income  - so a regular source of income is a must

- beginning a Chapter 13 case: debtor MUST file a voluntary petition - US Trustee appoints a trustee to supervise debtor - trustee also serves as central clearinghouse for debtor's payments to creditors - debtor pays the trustee who in turn transmits funds to creditors (keeping up to 10% of payments)

- plan of payment: debtor must file a plan of payment within 15 days  after filing the voluntary petition - only bankruptcy court has authority to confirm or reject a plan of payment - creditors have no right to vote on it - but to confirm a plan court must ensure that:

1. plan is feasible and bankrupt will be able to make the promised payments

2. plan does not extend beyond 3 years without good reason and in no event lasts longer than 5 years

3. plan does not provide for the debtor to pay off creditors in full then all of debtor's disposable income for the next 5 years must go to creditors AND

4. debtor is acting in good faith, making a reasonable effort to pay obligations

- discharge: once confirmed plan is binding on all creditors whether or not they like it - debtor is washed clean of all prepetition debts except those provided for in the plan


Chapter 7

Chapter 11

Chapter 13




Consumer reorganization

Who May Use It

Individual or organization

Individual or organization


Type of Petition

Voluntary or involuntary

Voluntary or involuntary

Only voluntary

Administration of Bankruptcy Estate


Debtor in possession (trustee selected only if debtor is unable to serve)


Selection of Trustee

Creditors have right to elect trustee; otherwise, U.S. Trustee makes appointment

Usually no trustee

Appointed by U.S. Trustee

Participation in Formulation of Plan

No plan is filed

Both creditors and debtor can propose plans

Only debtor can propose a plan

Creditor Approval of Plan

Creditors do not vote

Creditors vote on plan, but court may approve plan without the creditors’ support

Creditors do not vote on plan

Impact on Debtor’s Post-Petition Income

Not affected; debtor keeps all future earnings

Must contribute toward payment of pre-petition debts

Must contribute
toward payment of
pre-petition debts

CHAPTER 16 test bank student.docx
Microsoft Word document [126.2 KB]

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