Laws and Contracts Lesson 29

1. Eagle Stores, Inc. borrows $5,000 each from EZ Loan Corporation, First National Bank, and Great Products Corporation. Eagle uses its “present inventory and any thereafter acquired” to secure the loans from EZ Loan and First National. EZ Loan perfects its interest on April 1, followed by First National on April 5. Eagle buys new inventory on April 10 from Great Products and signs a security agreement, giving Great Products a purchase-money security interest (PMSI) in the new inventory. On the same day, Great Products perfects its interest and notifies EZ Loan and First National.

Eagle takes possession of the new inventory on April 15. On April 20, Eagle defaults on all of the loans. • Whose security interest has priority? Great Products’s security interest has priority. Great products has a properly secured PMSI in inventory. They will prevail over EZ Loan and First National even though they properly secured before Great Products. Great Products has a PMSI and also notified the other creditors on April 10, before the debtor Eagle Stores, Inc. took possession of the new inventory on 15 April.

“The general rule to determine priority among creditors who possess perfected security interest in the same collateral is that the first security interest to be filed or perfected has priority over other filed or perfected security interests. Unless a subsequent security interest to be first perfected is a PMSI: (1) in after-acquired collateral which is perfected within 20 days; or (2) in inventory and proper notice is given”. Lesson Review Exercises 608-22-16, Q 10. The UCC does provides that in some instances a PMSI that is properly perfected, will prevail over another security interest in after-acquired collateral, even though the other was perfected first.

One such significant exception to the general rule is a PMSI in inventory. “A perfected PMSI in inventory has priority over a conflicting security interest in the same inventory, provided that the holder of the PMSI notifies the holder of the conflicting security interest on or before the time the debtor takes possession of the inventory (UCC9-324 (b))”. Chapter 29, page 569 bottom right 2. Don’s Training Center and Elite Fitness Corporation enter into a franchise agreement that provides it may be terminated at any time for “cause. ” Dons fails to meet Elite’s express membership sales quota. • Is this “cause” for termination?

Explain. Yes, this is cause for termination, if this was one of the termination criteria’s in the franchise agreement and failure to meet sales quota was stated as one of the causes for termination. The franchisee would be wise to have notice-and-cure provisions included in the contract to include for example, four consecutive months of failure to meet sales quota. The key word being “consecutive”. The franchisee could also have the franchise agreement include, “acts of god” clause, such as severe weather negatively impacting sales.

“Usually, the franchise agreement specifies that termination must be “for cause,” such as the death or disability’ of the franchisee, insolvency of the franchisee, breach of the franchise agreement, or failure to meet specified sales quotas. Most franchise contracts provide that notice of termination must be given. If no set time for termination is specified, then a reasonable time, with notice, is implied. A franchisee must be given reasonable time to wind up the business – that is, to do the accounting and return the copyright or trademark or any other property of the franchisor”.

Chapter 36, page 712, right side Don can be terminated because he failed to meet the specified sales quota. However, one way that he could choose to fight it is by proving that this “cause” may not be uniformly applied to the other franchise. That is if he believes he would not be throwing good money after bad in a losing franchise. 3. Owen plans to open Owen’s Pet Store, a pet supplies outlet, and to hire Quinn and Ruth. Owen will invest only his own money. He does not expect to make any profit for at least two years and to make almost no profit for the first three years, but he hopes to expand eventually.

• Which form of business organization would be most appropriate? There are a few factors for Owen to consider when choosing a business form for his startup. These include liability, taxation, continuity of life, and the legal formalities and costs associated with starting up the business. At this point in the startup of his small business, Owen’s Pet Store, I believe the two forms of business that could be appropriate for Owen are, Sole Proprietorship or Limited Liability Company (LLC). He could operate his business as a sole proprietorship, which is simpler to start and requires few legal formalities.

Also he would only pay personal income taxes and no corporate income tax. As he is projected to have little to no profits for the first three years there is no downside to the tax considerations. Once the business is under way, however, the sole proprietorship form may become problematic if additional investors are needed or the personal financial risks of the business become too great. One huge immediate risk that Owen will face is derived from his plans to hire employees. This increases his liabilities and exposes him to significant risk both personally and to his business.

As a sole proprietor his liabilities are unlimited and there are many unfortunate circumstances outside of his core business that could put him in financial ruin and bankruptcy. He could have workers’ compensation to cover workplace injuries to his Employees but this would not cover him for other types of lawsuits. To limit his liabilities I would recommend Owen choose the business form of the Limited Liability Company. Most states allow a single owner to form an LLC. Each business form has its own particular advantages and disadvantages. But a key consideration in starting up a business is whether the business form chosen will limit one’s personal liability for business debts and obligations.

If you form a limited liability corporation, you can normally avoid personal liability if, say, a customer slips and breaks his ankle in your store, sues your store, and is awarded damages by a court. Although the business entity may be liable for damages, you often will not be personally liable beyond what the business is worth Taxes are one of the critical factor to be considered in choosing a small-business form. A sole proprietorship is not a separate legal entity, and the owner pays taxes on business income as an individual.

All revenues are taxable, but business expenses can be deducted, so the owner is taxed only once on the business’s profits. Also the LLC is not taxed and members are taxed personally on profits “passed through” the LLC. I would recommend the LLC for Owen primarily because it allows him to avoid personal liabilities for business related mishaps and limits his liabilities only to what he chooses to invest in his business. 4. Sally and Tom decide to go into business selling discounted merchandise through their Web site “e-Buy. ” They sign a partnership agreement that requires Sally to contribute $12,000 and Tom to contribute $8,000 in capital to start the firm.

The agreement also states that only Sally will have the authority to bind the partnership in deals with third parties, but the agreement says nothing about the management of the firm or a division of profits. Without Sally’s knowledge, Tom tells United Computer Products, Inc. that he represents the firm and signs a contract with United to buy hard drives for resale on e-Buy. In the first year, e-Buy makes a profit of $50,000. • What are the partners’ rights with respect to the management of the firm?

“The agreement also states that only Sally will have the authority to bind the partnership in deals with third parties, but the agreement says nothing about the management of the firm or a division of profits. ” Lesson 29, Q 4. Because the partners never specified in writing the management role of each partner. They have equal rights in management of the company. “In general partnership, all partners have equal rights in managing the partnership (UPA 401 (f)). Unless the partners agree otherwise, each partner has one vote in management regardless of the proportional size of his or her interest in the firm. ” Chap 37, page 722, right side. • Is the partnership bound to the contract with United?

Yes, the partnership is bound to the contract with United Computer Products, Inc. The partnership agreement does states that only Sally will have the authority to bind the partnership in deals with third parties. But unless the partnership had filed in the appropriate state office a “statement of partnership authority” to limit certain partners capacity to act as the firm’s agent, the partnership has no recourse but to honor the contract. The partners would not be bound by the contract if United Computer Products knew that Tom did not have the authority to bind the firm to the contract and the partners could prove that the third party knew.

Tom broke a trust and did not abide by his fiduciary responsibilities. Partners stand in a fiduciary relationship to one another and it is a relationship of extraordinary trust and loyalty and imposes a responsibility upon each partner to act in utmost good faith for the benefit of the partnership. It requires that each partner subordinate his/her personal interest to the mutual welfare of the partners and a partner cannot engage in any independent competitive activities without the other partners’ consent.

• Do the partners split the first year’s profits? If so, how much is each entitled to? Yes, the partners will split the first years’ profits, equally. “The agreement also states that only Sally will have the authority to bind the partnership in deals with third parties, but the agreement says nothing about the management of the firm or a division of profits. ” Lesson 29, Q 4. “Each partner is entitled to the proportion of business profits and losses that is specified in the partnership agreement. If the agreement does not apportion profits (indicate how the profits will be shared), the UPA provides that profits will be shared equally. ”

Chap 37, page 722, right side If the agreement does not so specify, then profits are to be shared equally and losses are to be shared in the same ratio as profits. 5. Drew is an officer of Energy Fuel, Inc. Drew knows that an Energy engineer recently developed a new, inexpensive method for converting hydrogen into fuel. Drew takes advantage of this information to buy Energy stock from Gert and, after the discovery is announced, to sell the stock to Holly at a profit. Gert claims that this is a violation of federal law.

• Is Gert correct? If so, what federal law has Drew violated? If not, has Drew violated any law? Yes, Gert is correct, Drew’s actions are a violation of Federal Law. Drew is guilty of insider trading which is a violation of the Securities Exchange Act of 1934, Section 10 (b) and SEC Rule 10b-5. Drew is an officer of Energy Fuel, Inc. and is buying and selling stocks based on inside information he has as an Officer of his company. SEC Rule 10b-5 applies to almost all cases concerning the trading of securities.

Rule 10b-5, which prohibits the commission of fraud in connection with the purchase or sale of any security, imposes liability upon anyone for engaging in insider trading, which is trading securities based upon either receiving or having access to information of a non-public nature. Drew has a violation of insider trading. “Corporate directors, officer and others, such as majority shareholders, often have advance inside information that can affect the future market value of the corporate stock. Obviously, if they act on this information, their positions give them a trading advantage over the general public and other shareholders”. Chapter 42, page 820, right side.