This Document Contains Chapters 46 to 52 Chapter 46—Securities Regulation TRUE/FALSE 1. State laws designed to protect the public from the sale of worthless stocks and bonds are known as “clear sky” laws. Answer: False 2. The Securities Act of 1933 deals with the original distribution of securities by the issuing corporations. Answer: True 3. Under the 1990 Remedies Act, the SEC may start administrative proceedings against any person or entity, whether regulated by the SEC or not. Answer: True 4. The Securities Exchange Act of 1934 is concerned with the secondary distribution of securities in the national securities markets and in the over-the-counter markets. Answer: True 5. The Market Reform Act of 1990 empowers the SEC to suspend all trading when markets are excessively volatile. Answer: True 6. Securities covered by the securities acts includes only investment instruments such as stocks and bonds not "investment contracts." Answer: False 7. Under the United States Supreme Court’s definition, an investment contract exists if the following elements are present: (1) an investment of money, (2) a common enterprise, and (3) an expectation of future profits from the efforts of others. Answer: True 8. The Securities Act of 1933 prohibits the offering or sale of securities to the public in interstate commerce before a registration statement has been filed with the Securities and Exchange Commission (SEC). Answer: True 9. The Securities Act of 1933 requires a seller to provide a prospectus to each potential purchaser of an original issue of securities. Answer: True 10. At least 30 days must elapse from the date of a company's filing a registration statement with the SEC to the date the registration becomes effective. Answer: False 11. A prospectus sets forth the key information contained in the registration statement. Answer: True 12. All private or limited offerings of securities are exempt from the SEC registration requirements. Answer: False 13. Securities acquired under Rules 506, 505 and 404 exemption from registration are considered restricted securities, and their resale may require registration. Answer: True 14. Under SEC Rule 504 of Regulation D, an issuer can offer and sell up to $2 million in securities within a 12 month period without registration and without most of the restrictions contained in Rules 505 and 506. Answer: False 15. The Securities Act of 1933 imposes civil liability for making false or misleading statements in a registration statement. Answer: True 16. Exchanges, brokers, and dealers who deal in the securities traded in interstate commerce or on any national security exchange must register with the SEC unless exempted by it. Answer: True 17. Companies whose securities are listed on a national securities exchange and unlisted companies with assets in excess of $10 million and 500 or more shareholders are exempt from the reporting requirements of the Securities Exchange Act of 1934. Answer: False 18. Unlisted companies that have assets less than $10 million and fewer than 500 shareholders are subject to the reporting requirements of the Securities Exchange Act of 1934. Answer: False 19. The SEC requires that annual shareholder reports be submitted to shareholders in any proxy solicitation on behalf of management. Answer: True 20. The Sarbanes-Oxley Act of 2002 requires written certification of the 10-K and 10-Q reports by each company’s CFO and CEO. Answer: True 21. Rule 10b-5 only applies to registered securities. Answer: False 22. In every 10b-5 situation, the plaintiff must show "reliance" on the misrepresentation and a resulting injury. Answer: True 23. Under the Litigation Reform Act of 1995, issuers of forward-looking statements that were not knowingly false when made have a safe harbor from related lawsuits if appropriate cautionary language was included. Answer: True 24. The Litigation Reform Act of 1995 provides for joint and several liability for defendants who are found not to have knowingly committed a violation of the security laws. Answer: False 25. The Insider Trading and Securities Fraud Enforcement Act of 1988 gave the SEC authority to bring an action against an individual purchasing or selling a security while in possession of material, inside information. Answer: True 26. Individuals who steal valuable non-public information in breach of a fiduciary duty to their employers and trade in securities on that information are guilty of insider trading as “mis-appropriators.” Answer: True 27. Investors who lack inside information and have sold their stock during the relevant time period may recover damages from insiders who have made use of the undisclosed information. Answer: True 28. Any shareholder owning more than five (5) percent of any class of the corporation's equity securities is statutorily defined as an insider and must file with the SEC a disclosure statement regarding such ownership and all related transactions. Answer: False 29. A “short-swing” profit is realized by a corporate insider from selling corporate securities less than one (1) year after purchase. Answer: False 30. An accountant who prepares any statement, opinion or other legal paper filed with the SEC with the preparer’s consent is deemed to be practicing before the SEC. Answer: True MULTIPLE CHOICE 1. State statutes designed to protect the public from the sale of worthless stocks and bonds are called: A. antifraud acts. B. blue sky laws. C. clear sky laws. D. none of the above. Answer: B 2. Which of the following powers is not available to the SEC pursuant to the Remedies Act? A. The SEC may start administrative proceedings against any person or entity regulated by the SEC. B. The SEC may start administrative proceedings against any person or entity not regulated by the SEC. C. The SEC may order an accounting and disgorgement of ill-gotten gains. D. All of the above powers are available to the SEC under the Remedies Act. Answer: D 3. Federal regulation of the sale of securities is based on the: A. Securities Act of 1933 and the Securities Exchange Act of 1934. B. Securities Act of 1933 and the Federal Trade Act of 1936. C. Federal Trade Act of 1936 and the Blue Sky Act of 1933. D. Fair Stock Act of 1932 and the Investment Securities Act of 1934. Answer: A 4. Which of the following federal laws grants the SEC the power to suspend all trading when markets are excessively volatile? A. The Trust Indenture Act of 1939 B. The Market Reform Act of 1990 C. The Investment Advisors Act of 1940 D. The Remedies Act of 1990 Answer: B 5. An investment contract exists if which of the following elements are present? A. an investment of money B. a common enterprise C. an expectation of future profits D. all of the above Answer: D 6. A prospectus sets forth: A. the key information contained in the registration statement. B. information on stocks approved by the SEC. C. information that the SEC has not reviewed. D. none of the above. Answer: A 7. The registration requirement of the Securities Act of 1933 applies to: A. the issuing of stocks, bonds, and other investment securities. B. the issuing of certificates of deposit by a national bank. C. shares issued by nonprofit corporations. D. issues of $1.5 million or more. Answer: A 8. The registration process under Section 5 of the 1933 act is divided into three time periods. In order, they are: A. waiting, prefiling, and post effective. B. waiting, prefiling, and executory. C. prefiling, waiting, and pos teffective. D. prefiling, executory, and post effective. Answer: C 9. Provision for exemption from the registration requirements of the Securities Act of 1933 is made for offerings made solely to accredited investors by SEC Regulation: A. A. B. B. C. C. D. D. Answer: D 10. Which exemption to registration requirements exempts offerings of less than $5 million to no more than 35 nonaccredited purchasers over a 12-month period? A. Rule 504 exemption B. Rule 505 exemption C. Rule 506 exemption D. Rule 507 exemption Answer: B 11. Under Regulation D, Rule 506, sales may be made to: A. an unlimited number of accredited investors B. an unlimited number of unaccredited investors C. no more than 500 accredited investors D. no more than 35 unaccredited investors Answer: A 12. The Securities Exchange Act of 1934 deals with the __________ distribution of securities. A. primary B. secondary C. aftermarket D. direct Answer: B 13. SEC Rule 10b-5: A. is the principal antifraud rule relating to the secondary distribution of securities. B. provides that a civil action for damages may be brought by any private investor who purchased or sold a security and was injured because of false, misleading, or undisclosed information. C. applies to all securities, whether registered or not, as long as use is made of the mail, interstate commerce, or a national stock exchange. D. all of the above. Answer: D 14. The Litigation Reform Act of 1995 was passed because of: A. congressional concern over an excess of frivolous private securities lawsuits. B. the financial burdens placed on accountants and other professional advisors due to an excess of frivolous private securities lawsuits. C. concern that the investors in a class action lawsuit have their interests fairly represented. D. all of the above. Answer: D 15. An unlawful sale under the Insider Trading Sanctions Act of 1984 can result in a civil penalty of up to how many times the profit gained or loss avoided? A. two (2) B. three (3) C. four (4) D. five (5) Answer: B 16. A __________ insider is someone retained by the corporation for professional services, such as an attorney, accountant, or investment banker. A. professional B. corporate C. temporary D. virtual Answer: C 17. An individual who receives information from an insider or temporary insider is called a: A. tippee. B. tipper. C. de facto insider. D. virtual insider. Answer: A 18. A corporation may sue a director owning more than ten (10) percent of any class of corporate stock who makes a profit by selling any such stock: A. if the sale is made more than six (6) months after the original purchase of the stock by the director. B. only if the stock was originally acquired with fraudulent intent. C. only if the stock was sold with fraudulent intent. D. if the sale was made less than six (6) months after the original purchase of the stock by the director. Answer: D 19. A corporation or group of investors may seek to acquire control of another corporation by offering cash for all of its shares made available for sale by a certain date. This action is called a(n): A. cash tender offer. B. stock redemption offer. C. stock reclamation offer. D. offer for value. Answer: A 20. Which of the following acts was passed to ensure that public shareholders faced with a cash tender offer would not be required to respond without sufficient information? A. the Mann Act B. the Robinson-Patman Act C. the Williams Act D. the SEC Act Answer: C CASE 1. Mark Hubbard has been very successful in the cattle business over a number of years. Hubbard has decided to establish a cattle program as an investment tool. He will purchase cattle with investors' money and then provide medical care, feed, and transportation on a service contract basis. The profits then will be divided proportionately among the investors. An investment company, Money Ventures, Inc., is interested in the entire offering of Hubbard's cattle program. Hubbard is unsure as to whether the securities acts apply to him. In addition, he wonders whether his venture, as structured, is exempt if the activity is within the securities acts. Should Hubbard be concerned? Answer: For the security acts to apply, a transaction must involve a "security" within the meaning of the acts. The way that the term security has been interpreted allows the inclusion of almost any investment instrument within the confines of the securities acts. Certainly, Hubbard's offering is not one of stocks or of bonds, but it is an offering of an "investment contract" causing application of the securities acts. Hubbard's operation involves: (1) an investment of money; (2) a common enterprise; and (3) an expectation of future profits from the efforts of others. Despite being subject to the securities acts, Hubbard should qualify for an exemption. Under SEC Regulation D, offerings of any amount made solely to accredited investors, such as an investment company, are exempt from the registration requirements of the act. Additional arguments could be made for exemption under SEC Rules 504, 505, or 506. 2. Bart and his brother-in-law, Ted, owned a small corporation. Ted was basically an investor, and Bart ran the entire business. As Ted became increasingly remote from day-to-day operations, Bart began to falsify some records so that Bart could take a greater share of the profits. This continued for years with Bart mailing falsified financial statements to Ted. When Bart suddenly became ill, Ted was forced to assume a greater role in the business on a temporary basis. During this time, Ted discovered the past deceptions and sued Bart under Rule l0b-5 of the Securities Exchange Act of 1934. Bart defended on the procedural ground that the business was local and had never been involved in interstate transactions of any kind. Moreover, the corporation was not listed on any stock exchange, nor did it have assets in excess of $10 million or 500 or more shareholders. Comment on the outcome of this case. Answer: Bart will be held liable because the rule applies to all securities, registered or not, provided use is made of the mails for interstate commerce. The assets of and number of shareholders in the corporation have no bearing on the outcome of this case. Under Rule 10b-5, a civil action for damages may be brought by any private investor who purchased or sold a security and was injured because of false, misleading, or undisclosed information. 3. Taylor, a securities lawyer for a major Wall Street law firm, worked on numerous successful takeover bids of companies listed on the New York Stock Exchange. Prior to the public announcement of the takeover bids, Taylor provided information to Rogers (his stockbroker) and to Price (his mistress) about certain planned takeover bids on which he had provided legal services. Rogers, who was aware of the relationship between Taylor and Price, made purchases of the target companies on Rogers' and Price's behalf, netting them more than a million dollars in profits each. The SEC brings an action against Taylor, Rogers, and Price under Rule 10b-5 and the Insider Trading Sanctions Act of 1984. Taylor defends that he is an outsider not subject to the 1984 law and Rule 10b-5, and that he received no personal benefit. Rogers and Price defend that they were merely acting on stock market tips received from a person who did not personally benefit from the disclosure. Decide. Answer: Taylor is a temporary insider. Taylor breached his fiduciary responsibility to the shareholders by improperly disclosing the planned takeovers to Rogers and Price. Clearly, Taylor benefited from passing on the information because it provided a significant amount of money to his mistress, Price. Rogers was aware of the relationship between Taylor and Price. Both knew, or should have known, that Taylor was improperly disclosing the information. Triple damages would be appropriate for the severe misconduct in this case. Chapter 47—Accountants' Liability and Malpractice TRUE/FALSE 1. When an accountant makes a contract to perform services, there is a duty to exercise the skill and care that are common for the accounting profession. Answer: True 2. Malpractice is both a form of negligence and a tort. Answer: True 3. An accountant may be liable for malpractice if the accountant fails to detect signs that an employee of the client is embezzling. Answer: True 4. An accountant may be liable for damages if the accountant fails to inform a client of the tax consequences associated with selling a business. Answer: True 5. When an accountant fails to complete a contract, the accountant is still entitled to the accountant's fee. Answer: False 6. Breach of contract remedies are available to third parties against accountants because they are ordinarily considered third-party beneficiaries of contracts with accountants. Answer: False 7. A client may recover tort damages from an accountant for fraud and gross negligence, but not for ordinary negligence. Answer: False 8. In an action for breach of contract, the statute of limitations runs from the date on which the harm is discovered. Answer: False 9. In order to be valid, an accountant’s disclaimer of liability must be (1) clear and unambiguous and (2) non-conspicuous. Answer: False 10. Any disclaimer by an accountant that excludes liability for malpractice based on negligence is void. Answer: False 11. A disclaimer that protects an accountant from liability for inaccurate reporting of certain specified financial information will be held valid if the accountant had no means of examining the information. Answer: True 12. Disclaimers of liability are valid when the circumstances are such that it is not reasonable to expect the accountant to stand behind certain data. Answer: True 13. A disclaimer based on lack of knowledge will always protect an accountant from liability. Answer: False 14. In some states an exculpatory clause protects the accountant from a malpractice suit brought by a third party but now from a suit brought by a client. Answer: False 15. What constitutes negligence is the same for an accountant who is a full-time employee as it is for an independent outside auditor. Answer: True 16. The privity rule permits the filing of an accounting malpractice lawsuit by a third party against an accountant. Answer: False 17. When the privity rule is applied, a bank lending money to the client of an accountant cannot sue the accountant for malpractice. Answer: True 18. New York follows the “contact” rule in determining when third persons can sue accountants for negligence. Answer: True 19. The contact rule does not require that the accountant meet or communicate with the third party to establish a relationship equivalent to privity. Answer: False 20. Under the “known-user” rule, it is sufficient if a user is a member of a known class, even if the identity of the particular user is not known to the accountant. Answer: True 21. The “known user” rule imposes liability on the accountant for negligent malpractice when he or she can foresee the parties who will rely on his work in the financial statements. Answer: False 22. According to the intended user rule the accountant must have furnished the information directly to the non-privity user or to the client knowing that they client would transmit the information. Answer: True 23. Some courts have rejected the requirement of privity for malpractice and instead approach each situation on a case-by-case basis. Answer: True 24. An entity not in privity with an accountant is prohibited from recovering against the accountant for malpractice when the accountant had no knowledge of any use that could affect the party. Answer: True 25. Accountants are equally liable to interlopers and rightful third parties. Answer: False 26. The contributory negligence of the client does not reduce the liability of an accountant who is liable for malpractice. Answer: False 27. In contrast to contributory negligence principles, comparative negligence principles are never applied to malpractice situations. Answer: False 28. For accountants, fraudulent malpractice always involves upgrading the financial condition of the firm. Answer: False 29. Third persons are prohibited from recovering from an accountant who commits fraud. Answer: False 30. One of the concerns reflected in Sarbanes-Oxley was that auditors were not exercising sufficient discretion and independence in conducting audits of their clients. Answer: True MULTIPLE CHOICE 1. Professionals who fail to exercise normal care and skill in the performance of a contract for their services may be sued for a special type of breach described as: A. sub par performance. B. illegal practice. C. malpractice. D. competence reservation. Answer: C 2. To bring a tort action for malpractice, a plaintiff must show that the defendant's breach was at least: A. intentional. B. negligent. C. reckless. D. fraudulent. Answer: B 3. An accountant guilty of malpractice can be sued: A. for breach of contract only. B. for negligence only. C. for breach of contract or for tort liability. D. in federal court only if the suit is brought by a third person. Answer: C 4. The statute of limitations in a tort action for malpractice runs from: A. the date when the harm occurs. B. the date when the harm is discovered. C. the date when the plaintiff determines the total amount of damages caused by the harm. D. either the date when the harm occurs or when it is discovered, depending on the type of damages sustained. Answer: B 5. Misrepresentation: A. is the same as fraud. B. is a false statement of fact made with the intent to deceive. C. is a false statement of fact made without any intent to deceive. D. can be used as a limitation to excuse an accountant from liability. Answer: C 6. An exculpatory clause most likely would be held to limit or disclaim liability for malpractice: A. in an action based on fraud. B. in a suit brought by a third person. C. when the accountant can reasonably be expected to stand behind the information in question. D. when the clause is conspicuous, unambiguous, and clear. Answer: D 7. The privity rule: A. allows for an accountant’s client to recover from an accountant in a negligence malpractice suit. B. allows for a third part to recover from an accountant in a negligence malpractice suit. C. both a. and b. D. neither a. nor b. Answer: A 8. An accountant may be able to raise the defense of lack of privity in a malpractice suit: A. brought under federal securities statutes. B. based on negligence. C. based on fraud. D. all of the above. Answer: B 9. The contact rule applies in which of the following states? A. Alabama B. Indiana C. New York D. All of the above Answer: C 10. Under the known user rule: A. the accountant is not liable to any third parties who experience a loss as a result of the accountant’s negligence. B. the accountant is liable to all third parties who experience a loss as a result of the accountant’s negligence. C. the accountant is liable to third parties who experience a loss as a result of the accountant’s negligence but only if the accountant knew the third party would be using the work product. D. the accountant is liable to third parties who experience a loss as a result of the accountant’s negligence but only if the accountant’s client gave the work to the third party. Answer: C 11. Unidentified members of a certain class may sue for negligent malpractice in states that follow the __________ rule. A. contact B. known user. C. unidentified user D. foreseeable user Answer: D 12. When an accountant negligently prepares a financial statement knowing that the client intends to use it in obtaining a loan from a bank, the accountant will be liable to whichever lender actually makes the loan under the __________ rule. A. known user B. contact C. foreseeable user. D. privity Answer: C 13. Some states have rejected the requirement of privity but not adopted any set rule. Instead, these states function under the __________ rule. A. known user B. contact C. flexible D. foreseeable user Answer: C 14. __________ courts impose liability on the accountant to a total stranger who gets possession of the accountant's work and then sustains a loss because of a false statement in the work. A. No B. A minority of C. A majority of D. All Answer: A 15. An accountant who is being sued by a third person for malpractice based on fraud will be able to avoid liability if the accountant can show: A. contributory negligence on the part of the plaintiff. B. that an exculpatory clause applies. C. that the plaintiff did not rely on the false statement. D. the absence of privity of contract. Answer: C 16. The Public Company Oversight Board: A. is a governmental body. B. must have at least three board members that are CPAs. C. enforces rules to ensure audit quality and auditor independence. D. all of the above. Answer: C 17. To help eliminate conflicts of interest, Sarbanes-Oxley prohibits certain activities by audit firms for their audit clients, including: A. the design and implementation of financial information systems. B. actuarial services. C. management functions and human resources. D. all of the above. Answer: D 18. To ensure that audit partners do not become entrenched, Sarbanes-Oxley requires audit firms to change audit partners at least once every __________ years. A. three (3) B. five (5) C. seven (7) D. ten (10) Answer: B 19. Sarbanes-Oxley would prohibit which of the following individuals from serving on an audit committee of the company’s board? A. a director who accepts consulting fees from the company B. a director who is affiliated with the company C. a director who is affiliated with a subsidiary of the company. D. all of the above. Answer: D 20. Which of the following statements is true? A. Auditors are always eligible for whistleblower awards. B. Auditors are only eligible for whistleblower awards if they report information to the board of directors and the board fails to take action. C. Auditors are only eligible for whistleblower awards if they report conduct by a company that is intended to inhibit an SEC investigation. D. Auditors are never eligible for whistleblower awards. Answer: D CASE 1. Horseco, a new business, purchased ten thoroughbred horses for racing and breeding purposes. It hired John, an accountant, to prepare financial projections of anticipated future earnings for the first five (5) years of the new business. The information provided to John as the basis for the projections included assumptions made by Horseco about anticipated earnings from racing and breeding. The assumptions were based on Horseco's experience and were not based on objective standards that could be examined by John. John included with the projections a disclaimer that stated that the income projections were based on assumptions provided by Horseco and that John assumed no personal responsibility for the accuracy of those projections. Subsequently, the Larson Company purchased a fifty (50) percent interest in Horseco, and when Horseco's income did not match the projections, Larson sued John for accounting malpractice. How will the court decide? Answer: Judgment will be for John. Disclaimers permit an accountant to limit or disclaim liability if, under the circumstances, it is unreasonable to expect the accountant to stand behind certain information and the disclaimers make it clear that the accountant does not vouch for the disclaimed information. In this case, the assumptions regarding future income could not be objectively verified by John, and it would therefore be unreasonable to subject John to liability when future earnings failed to meet Horseco's projections. 2. Herman hires Juanita as his accountant. Juanita commits negligence in preparing financial statements for a business Herman owns. Several investors rely on the financial statements and purchase shares of stock in the business. In a state that has adopted the privity rule, what result? Answer: The privity rule holds that only the accountant's client may sue an accountant for malpractice. Therefore, any investors who rely on the incorrect financial statements are prohibited from recovering for their losses. 3. Sara and Sally rely on the statements of Alice, an accountant. In a lawsuit brought by Sara and Sally against Alice for fraud, Alice seeks to avoid liability based on the fact that neither Sara nor Sally was in privity of contract with Alice. Alice knew Sara might rely on the financial information provided, but Alice did not know of Sally or anyone in her position. Can Sara and Sally recover against Alice? Answer: Sara will be able to recover against accountant Alice for fraud because privity is immaterial in considering the issue of whether an accountant is liable for fraud. Sally will not recover, however, because the third person must either be known to the accountant or a member of a class known to the accountant. Chapter 48—Management of Corporations TRUE/FALSE 1. In a large corporation, the shareholders are often the managers of the corporation. Answer: False 2. Shareholder control is generally limited to voting at shareholders’ meetings to elect directors. Answer: True 3. The sale of corporate assets outside the regular course of a corporation's business is an example of an extraordinary matter. Answer: True 4. Ordinarily, action by shareholders has legal effect as a corporate act only if such action is taken at a regular or special meeting of the stockholders. Answer: True 5. The notice of a special meeting of shareholders must include a statement of the nature of the business to be transacted and no other business may be transacted at such a meeting. Answer: True 6. A quorum is broken if shareholders leave and those remaining are not sufficient to constitute a quorum. Answer: False 7. Action taken by shareholders without holding a meeting is valid under the RMBCA if it is evidenced by a written consent signed by all the shareholders entitled to vote on the action. Answer: True 8. A board of directors’ oversight responsibilities for its company’s business affairs do not include evaluating management’s performance. Answer: False 9. All states stipulate that there shall be no fewer than three directors for each corporation. Answer: False 10. A board of directors may enter into any contract or transaction necessary to carry out the business for which the corporation was formed. Answer: True 11. A director is disqualified from taking part in corporate action with respect to a matter in which the director has an undisclosed conflicting interest. Answer: True 12. A corporation generally may avoid a transaction because of a director's secret disqualification, such as a conflict of interest. Answer: True 13. Directors are usually allowed to vote by proxy. Answer: False 14. Most states permit action to be taken by the board of directors without holding an actual meeting. Answer: True 15. In dealing with the corporation, directors act in a fiduciary capacity. Answer: True 16. The business judgment rule is applied by the courts as a presumption that must be overcome by the person challenging a director's actions. Answer: True 17. The courts have traditionally viewed it as their responsibility to sit in judgment on the wisdom of decisions made by corporate directors. Answer: False 18. State laws that attempt to indemnify corporate directors against personal monetary liability for gross negligence are void as contrary to public policy. Answer: False 19. According to the RMBCA, shareholders may, by majority vote, remove a director with or without cause unless the articles of incorporation provide that directors may be removed only for cause. Answer: True 20. The duties of officers of a corporation are generally set forth in the articles of incorporation. Answer: False 21. The powers of the officers of a corporation are controlled by the laws of agency. Answer: True 22. The president of a business corporation does not have implied authority to execute commercial paper in the name of the corporation. Answer: True 23. The authority of corporate employees and other officers is generally limited to the duties of their offices. Answer: True 24. Corporate officers may avail themselves of all business opportunities that come to them in an individual capacity regardless of whether or not the opportunity lies within their field of duty. Answer: False 25. The officers of a corporation are liable for errors of judgment that cause a loss to the stockholders. Answer: False 26. Ordinarily, the management of a corporation is not liable to third persons if the managerial policies cause loss to such third persons. Answer: True 27. Officers that cause a corporation to break a contract with third party are liable to the third party even if they acted in good faith to advance the interests of the corporation. Answer: False 28. Officers and directors are not personally responsible for crimes they have committed when it can be demonstrated that in carrying out such crimes, they acted on behalf of the corporation. Answer: False 29. A corporation may be convicted of a criminal offense if it is shown beyond a reasonable doubt that the offense was committed by its agent acting within the scope of the agent's authority. Answer: True 30. Officers and directors may be criminally liable for failure to prevent the commission of a crime if they are found to be the “responsible corporate officers.” Answer: True MULTIPLE CHOICE 1. Regular meetings of shareholders are: A. held at a time and place set forth in a notice given to all shareholders. B. held at a time and place prescribed by the articles of incorporation or the bylaws. C. called by the directors. D. limited to the election of directors. Answer: B 2. A valid meeting of the voting shareholders of a corporation requires the presence of a: A. quorum. B. forum. C. majority. D. voting majority. Answer: A 3. Eligibility for membership on a board of directors is determined by all of the following except: A. statute. B. certificates of filing. C. articles of incorporation. D. bylaws. Answer: B 4. Which of the following is an incorrect statement about directors? A. Their eligibility requirements may be found in the bylaws. B. Bylaws may require that directors be shareholders in the corporation. C. The board of directors has authority to manage the corporation. D. Courts will interfere with the board's discretion when they disagree with its actions. Answer: D 5. The __________ rule allows management immunity from liability for corporate acts where there is a reasonable indication that the acts were made in good faith and with due care. A. sovereign immunity B. business judgment C. reasonable director D. good faith Answer: B 6. The Sarbanes-Oxley Act prohibits all corporate loans to directors and executive officers unless: A. the company is in the consumer credit business. B. the loan is to relocate as part of an employment contract. C. the loan is made to purchase securities. D. none of the above as all loans are prohibited. Answer: A 7. What is not part of the presumptions of the business judgment rule concerning directors? A. that the decision they reached was profitable to the corporation B. that they acted on an informed basis C. that they acted in good faith D. that they acted in the honest belief that the action taken was in the best interest of the corporation Answer: A 8. A stockholder-approved amendment to the certificate of incorporation may indemnify directors who: A. acted in bad faith. B. acted negligently. C. breached their duty of loyalty. D. gained an improper personal benefit. Answer: B 9. The RMBCA provides that, absent a conflicting provision in the articles of incorporation, directors may be removed: A. with or without cause by a majority vote of the shareholders. B. with cause by a majority vote of the shareholders, and without cause by a unanimous vote. C. with or without cause by a unanimous vote of the shareholders. D. only with cause. Answer: A 10. Which of the following is an incorrect statement about officers? A. Their duties are generally set forth in the corporation's bylaws. B. They have a fiduciary obligation to the corporation. C. They are agents of the corporation. D. Their authority as agents is increased if they are shareholders. Answer: D 11. A president of a corporation does not have the authority to: A. make a long-term employment contract. B. mortgage a corporate property. C. release a claim of the corporation. D. perform any of the above acts. Answer: D 12. If an officer diverts a corporate opportunity, the corporation may recover from the officer: A. triple damages for breach of a fiduciary duty. B. the profits of which the corporation has been deprived. C. past wages for the time period in question. D. any and all funds used to divert the corporate opportunity. Answer: B 13. A corporate officer, while still employed by his or her firm, may be in breach of the officer’s fiduciary duty of __________ by recruiting key management employees to join a competing company. A. obedience B. loyalty C. conflict of interest D. confidentiality Answer: B 14. The relationship between a corporation and its agents is governed by the: A. statute under which the corporation was formed. B. corporate charter. C. corporate bylaws. D. same rules as are applicable when the principal is a natural person. Answer: D 15. Under which of the following scenarios would a third person be able to successfully sue a corporate manager if the manger’s advice to the corporation causes loss to the third person? A. The manager’s advice has resulted in the corporation’s successful underselling of the third person's product. B. The manager’s advice has resulted in the corporation’s breach of a contract with the third person under which the corporation was losing a substantial sum of money. C. The manager’s advice has resulted in the corporation’s refusal to deal with the third person because the third person has not maintained the standards and quotas set by the corporation. D. none of the above. Answer: D 16. A corporation may be prosecuted and convicted of: A. a criminal offense if its agent committed the offense while acting within the scope of the agent’s authority. B. an error in business judgment, assuming that no other reasonable corporation would have committed such an error. C. operating without a corporate charter if the corporation has never sought a charter from the secretary of state’s office, or if its directors and/or officers either knew of should have known that the secretary of state’s office had revoked the charter. D. none of the above; a corporation itself is not subject to criminal prosecution and conviction. Answer: A 17. Corporations may ________ officers, directors, employees, and agents when they act in good faith, in a manner not opposed to corporate interests and with no reason to believe their conduct was unlawful. A. ratify B. breach C. indemnify D. authorize Answer: C 18. The means by which stockholders may seek to protect themselves against corporate actions to which they object include all of the following except: A. voting in new directors. B. bringing legal action. C. voiding the charter. D. calling a special stockholders' meeting. Answer: C 19. A corporation is liable to a third person for the act of its agent: A. to the same extent as a natural person would be liable. B. only if the agent was expressly authorized to perform the act. C. only if the agent's act was a crime. D. only if the agent's act was based on an intent to benefit the corporation. Answer: A 20. In addition to the corporation itself, which of the following parties are ordinarily responsible for corporate debts? A. directors B. officers C. directors and officers D. none of the above Answer: D CASE 1. The stockholders of the Apex Corporation attended a special meeting of the stockholders called to discuss matters of extreme urgency to the corporation. A quorum was not present when the meeting opened, nor was a quorum present when the matters to be treated in the meeting were discussed. Management, however, felt that the importance of the issue was significant enough to warrant continuation of the meeting without a quorum, and the stockholders voted on the issues presented during the meeting. During the last fifteen (15) minutes of the meeting, just prior to the cocktail hour regularly attended by many stockholders, enough stockholders had arrived to constitute a quorum. Were the issues of this meeting dealt with in a valid manner? Answer: No. It is necessary that a valid stockholders' meeting open with a quorum. If this occurs, it is not necessary that the quorum be maintained through the course of the meeting. The voting at this meeting is not binding. 2. All of the directors of the XYZ Corporation were present at a meeting called on a Monday evening at 9 p.m. Meetings normally were held on Friday evenings at 6 p.m. At the Monday meeting, a report was made indicating that an agent of the corporation was having difficulties formalizing a contract in a foreign country. The report indicated that if funds were made available to a local political figure, the contract the company desired would be obtained. The directors unanimously voted to forward the necessary funds for this operation to the agent. An action was later commenced against the directors, alleging illegal activities. In response, the directors argue that: (1) no illegal activity had occurred; (2) if an illegal activity did occur, it was not at a valid meeting of the corporation and was therefore not an official action of the board; and (3) if they had to legally defend themselves, they would seek reimbursement from the corporation. Discuss the directors' contentions. Answer: Meetings of the board of directors are often held uniformly as to time and place; however, there is no prohibition against holding a meeting at an alternate time and place. Because none of the directors had objected to the irregular meeting on Monday, none could later argue to invalidate the actions taken within that meeting. The Foreign Corrupt Practices Act makes it a crime to bribe a foreign official to use influence to obtain business for an American corporation. Violation of the act subjects individuals to possible fines and imprisonment. The RMBCA broadly authorizes a corporation to indemnify individuals if they acted in good faith and in a manner reasonably believed to be lawful. Because individuals are charged with knowing the laws, it could be argued that the directors knowingly acted in an unlawful manner and are therefore not eligible for indemnification. 3. Ping was the president and chairman of the board of directors of Oh Imports, Inc. Ping was also a major shareholder. Acting as president, Ping negotiated a series of contracts that caused the corporation serious economic losses. In this role, Ping failed to exercise the care of a reasonably prudent person acting in similar circumstances. When substantial economic losses began to pile up, Ping insisted that the corporation breach a contract with Ory in favor of a larger contract that was later entered into with Magnificent Enterprises. Ping hoped to reverse Oh's economic fortunes through this contract with Magnificent, but the attempt failed. Oh then became insolvent. Ultimately, the corporation failed. Two law-suits were initiated against Ping. In the first, a creditor of Oh who never was paid because the business failed sued Ping alleging that the negligence of Ping had caused Oh to fail to pay the creditor what was owed. The second lawsuit instituted by Ory claimed damages from Ping because Ping caused Oh to breach its contract with Ory. Decide both lawsuits. Answer: Management is not liable to third persons for the effect of their management or advice on such third persons. Officers and directors are not liable to outsiders for loss caused by the negligent performance of their duties as officers or directors. Similarly, officers and directors are not liable for the economic consequences of their advice on third persons, even if they cause the corporation to breach a contract with such third persons, provided they acted in good faith to advance the interests of the corporation. Ping has no liability in either lawsuit. Chapter 49—Real Property TRUE/FALSE 1. Real property includes land and all rights in land. Answer: True 2. Technically, land is considered as extending downward to the earth's center and upward indefinitely. Answer: True 3. The general view is that the owner of land owns the space above the land, subject to the rights of flying aircraft, even if the aircraft interferes with the use of the land and represent a danger to persons or property on the land. Answer: False 4. An easement is a right to use another’s property that belongs to the land that is benefited. Answer: True 5. An easement may be created only by deed. Answer: False 6. An easement may be destroyed by an act of the grantor. Answer: False 7. The right to cut firewood from another's property would constitute a profit. Answer: True 8. A license is different from an easement in that it is a personal, revocable privilege to do something on the land of another. Answer: True 9. A license may be terminated at the will of the licensor. Answer: True 10. Liens on land may be created voluntarily by the owner of land or involuntarily against the wishes of the owner. Answer: True 11. A fixture is personal property that has been attached to the earth or placed in a building in such a way or under such circumstances that it has become part of the real property. Answer: True 12. Personal property that has become a fixture is still classified as personal property. Answer: False 13. If the parties involved agree that personal property will be considered a fixture, it will be deemed to be a fixture without the application of legal tests. Answer: True 14. Personal property generally becomes a fixture if it is so attached to the realty that it cannot be removed without materially damaging the realty. Answer: True 15. A trade fixture is a fixture that is traded in by the owner when purchasing new fixtures. Answer: False 16. Under a freehold estate, a person owns property only for a specified number of years. Answer: False 17. An estate in fee simple grants ownership in property for a specific period of time. Answer: False 18. At common law, the occupier of land owed the same duty to both licensees and invitees. Answer: False 19. Small children are afforded additional protection against the trespass rule through the “attractive nuisance” doctrine. Answer: True 20. Licensees are on the premises with the permission of the landowner. Answer: True 21. A condominium is a combination of co-ownership and individual ownership. Answer: True 22. A condominium and a cooperative are essentially the same. Answer: False 23. A deed, like a contract, must be supported by consideration to be effective. Answer: False 24. A quitclaim deed must specify what interest is being transferred in order to be valid. Answer: False 25. A deed is not effective to pass title unless it is properly recorded. Answer: False 26. Recording statutes provide that a person purchasing land from the last holder of record will take title free of any unrecorded claim to the land of which the purchaser does not have notice or knowledge. Answer: True 27. Title to land may be acquired by adverse possession. Answer: True 28. In general, any form of property that may be sold or conveyed may be mortgaged. Answer: True 29. An unrecorded mortgage is not valid and binding between the parties. Answer: False 30. The rights of the mortgagor after default include the right to obtain a stay of foreclosure to prevent undue hardship and a right of redemption. Answer: True MULTIPLE CHOICE 1. Real property includes: A. land. B. shrubs, grass and tress. C. rights in the land of another. D. all of the above. Answer: D 2. A personal, revocable privilege to perform an act or series of acts upon the land of another is called a(n): A. easement. B. tenement. C. license. D. lien. Answer: C 3. Personal property that is attached to the earth or placed in a building in such a way or under such circumstances that it is deemed part of the real property is called a(n): A. asset. B. estate. C. easement. D. fixture. Answer: D 4. Which of the following statements is incorrect about fixtures? A. Personal property may become a fixture by annexation to the realty. B. Personal property may become a fixture by adaptation to the realty. C. Personal property may become a fixture based on the intent of the person affixing the personal property to the realty. D. Personal property that is readily removable from the realty is generally a fixture. Answer: D 5. Equipment attached to a rented building by a tenant and used in business is: A. called a trade fixture. B. called a business fixture. C. called a commercial fixture. D. not a fixture. Answer: A 6. Characteristics of the fee simple estate include all of the following except: A. it is alienable during life. B. it is not subject to rights of the owner's surviving spouse. C. it is alienable by will. D. it can be attached or used to satisfy the owner’s debts before or after the owner’s death. Answer: B 7. Which of the following represents a duty owed by a landowner to a trespasser? A. the duty to refrain from causing intentional harm once the presence of the trespasser is known B. the duty to warn the trespasser of dangers existing on the premises C. the duty to make the premises safe to protect the trespasser from harm D. none of the above, since a landowner has no legal duty to a trespasser Answer: A 8. Small children who trespass on land may be owed a special duty of care based on the doctrine of: A. caveat emptor. B. res ipsa loquitur. C. comparative negligence. D. attractive nuisance. Answer: D 9. To which of the following parties does the landowner owe a duty to take reasonable steps to discover any danger and a corresponding duty to warn the party of or correct the discovered danger? A. trespasser B. licensee C. invitee D. all of the above Answer: C 10. A __________ is a combination of co-ownership and individual ownership. A. cooperative B. residential lease C. commercial lease D. condominium Answer: D 11. What type of deed merely transfers whatever interest, if any, the grantor may have in the property, without specifying that interest in any way? A. common law B. statutory C. quitclaim D. warranty Answer: C 12. Which is not a correct statement about deeds? A. The grantor must sign the deed. B. A deed must be recorded to effectively pass title. C. The fact that a deed is recorded provides notice to the world about who holds title. D. A deed must be delivered to be effective. Answer: B 13. Which of the following can constitute an effective delivery of a deed? A. a physical delivery B. a symbolic delivery C. a constructive delivery D. all of the above Answer: D 14. A summarized report of title to property is called: A. title protection insurance. B. title assessment insurance. C. an abstract of title. D. an instrument of title. Answer: C 15. A guarantee that the grantor owns the estate conveyed is called a covenant: A. of right to convey. B. against encumbrances. C. of quiet enjoyment. D. of seisin. Answer: D 16. A covenant that passes with the land so that whoever owns the land is bound by or entitled to the benefit of the covenant A. is a covenant of seisin. B. is a covenant of further assurances. C. is a covenant of quiet enjoyment. D. is said to run with the land. Answer: D 17. A promise that the grantor of an interest in land will execute any additional documents required to perfect the title of the grantee is known as a covenant: A. of seisin. B. of further assurances. C. against encumbrances. D. of quiet enjoyment. Answer: B 18. Property may be taken from its private owner and the title acquired by the taking government or public authority under the power of: A. a restrictive covenant. B. eminent domain. C. an affirmative covenant. D. restraint. Answer: B 19. Which statement is incorrect concerning mortgages? A. The mortgagee's interest terminates upon performance of the obligation secured by the mortgage. B. The mortgagee has the right to enforce the mortgage by foreclosure upon default by the mortgagor. C. The mortgagor must have complete or absolute ownership in the property. D. Generally, no particular form of language is required to create a mortgage. Answer: C 20. In general, a mortgagor is under a duty to: A. make improvements to the mortgaged property. B. insure the property. C. pay taxes and assessments on the property. D. reimburse the mortgagee for expenditures made by the mortgagee for valuable and lasting improvements. Answer: C CASE 1. Frank has two interests in property. On property "X," Frank has a life estate measured by the life of his Uncle Sal. On property "Y," Frank has a fee simple estate. Frank wishes to transfer, upon his death, his interest in the two properties to his wife, Samantha. Prior to Frank's executing his will, Uncle Sal dies. Frank still wishes to will the properties to his wife, but he now is uncertain whether he has the right to do so. Can Frank will the two property interests to Samantha? Answer: Frank had a life estate interest in property "X." Frank could use and enjoy the property as long as the measuring-life individual still lived. Once the person whose life is the measuring life dies, Frank's interest in the property ceases. Frank has no interest remaining in property "X" to transfer to Samantha. An estate in fee simple lasts forever and is alienable by will. Frank may freely will his interest in property "Y" to Samantha. 2. Ulysses bought White acre from Gordon but never recorded the deed. Gordon stayed on the property as a tenant for three (3) years. Near the end of the three (3) years, Gordon learned that Ulysses had never recorded the deed. Gordon advertised White acre for sale and Cheryl negotiated with Gordon thinking that Gordon was the owner. Finally, Cheryl checked the records at the recording office and, finding no reason to question Gordon’s ownership of the property, purchased White acre from Gordon. Cheryl recorded the deed and Gordon fled with the purchase money. Meanwhile, Ulysses had failed to pay the real estate taxes on White acre for the three (3) years in question thinking it was the responsibility of Gordon, the tenant. Ultimately, Cheryl and Ulysses disputed over the ownership of the property. Decide the case between Cheryl and Ulysses. Also decide whether Ulysses is responsible for the three (3) years of real estate taxes assessed while Gordon occupied the property as a tenant. Answer: Ulysses loses on both counts. Ulysses was the owner of White acre when Ulysses purchased the property and received the deed. As the owner, Ulysses was responsible for the real estate taxes. Because Ulysses failed to record the deed, a good faith purchaser, Cheryl, who relied on the records and did not know of Ulysses' ownership, defeats that ownership and becomes the owner. Cheryl ends up the owner of the property. 3. Tucker and Hankey were adjoining property owners. Tucker claimed that the fence separating their properties was not located properly and that it should be moved back onto Hankey's land. Hankey claimed that he owned the strip between the fence and the alleged boundary line by adverse possession. He proved that for forty (40) years there had been on the strip in question a barn with a cement floor, which had been built by the person from whom he purchased his land, and that he had been told by the former owner that the fence was the boundary line. The fence consisted of five-foot-high barbed wire set in cement. Did Hankey own the strip by adverse possession? Answer: Yes. The construction of a valuable improvement such as the barn, and the nature of the fence, showed that Hankey and the former owner had regarded themselves as the owners of the land in possession. Their possession was adverse and continuous, and it therefore satisfied the requirements of adverse possession. Chapter 50—Environmental Law and Land Use Controls TRUE/FALSE 1. The first federal legislation that dealt with air pollution was the Air Pollution Control Act of 1955, which was simply a statutory recognition of a concern about air quality. Answer: True 2. States that do not meet federal standards under The Clean Air Act are known as nonattainment areas. Answer: True 3. A method for determining total emissions in one area is referred to as the emissions offset concept. Answer: False 4. Under the Clean Water Act, the EPA has developed effluent guidelines, which are ranges for discharges organized according to industrial groups and for specific plants in each of these groups. Answer: True 5. Solid waste disposal regulations today deal almost entirely with recycling. Answer: False 6. Funds from the Superfund are used to pay the cost of eliminating or containing condemned waste sites. Answer: True 7. The federal government is not subject to any type of environmental quality regulation Answer: False 8. The Noise Control Act sets the standards for lawn mowers, automobiles, and other devices often found in suburban neighborhoods. Answer: False 9. Both the Secretary of Commerce and the Secretary of the Interior are given responsibilities under the Endangered Species Act. Answer: True 10. Only government agencies can sue for violations of an environmental protection control. Answer: False 11. The EPA has the authority of have activities halted through the use of injunction. Answer: True 12. Both companies and their employees are subject to criminal penalties for violations of federal environmental laws. Answer: True 13. The EPA is the primary federal agency responsible for the enforcement of environmental laws. Answer: True 14. Private citizens lack the authority to have polluting activities halted through the use of injunctions. Answer: False 15. Conduct that unreasonably interferes with the enjoyment of land is a nuisance. Answer: True 16. The fact that harm occurred is sufficient to establish a nuisance. Answer: False 17. Nuisances may be classified as either private nuisances or public nuisances. Answer: True 18. Planting trees or erecting a fence, although otherwise lawful, constitutes a public nuisance when it creates a traffic hazard by obscuring an intersection. Answer: True 19. A civil nuisance may be terminated by abatement or closure by government authority, while a criminal nuisance is not subject to such action. Answer: False 20. Due diligence is the process by which the buyer of property conducts a thorough investigation of the property and its uses to determine whether environmental or nuisance problems exist. Answer: True 21. Due diligence usually consists of searching public records and inspecting the land. Answer: True 22. If a restrictive covenant is valid, it binds only the original grantee in the deed that created the covenant. Answer: False 23. If any uncertainty exists in the interpretation of a restrictive covenant, the covenant will be construed strictly in favor of the free use of the land. Answer: True 24. The object of zoning is to ensure an orderly physical development of the geographic area that is regulated. Answer: True 25. Public zoning and restrictive covenants in deeds have a similar purpose, but each has a different source of authority. Answer: True 26. The zoning power permits any regulation that is conducive to advancing public health, welfare, and safety. Answer: True 27. A right to a nonconforming use of land cannot be lost through abandonment. Answer: False 28. A variance permits an owner of land to use it in a specified manner that is inconsistent with zoning ordinances. Answer: True 29. Spot zoning may result in such inequality as to be condemned by the courts. Answer: True 30. When the desired use of land is in harmony with the general nature of surrounding areas, a zoning variance is usually granted. Answer: True MULTIPLE CHOICE 1. Which federal agency is most often authorized to adopt standards and regulations to carry out the provisions of environmental statutes? A. FTC B. ICC C. EPA D. SEC Answer: C 2. The bubble concept: A. refers to dirty areas that do not meet federal standards under the Clear Air Act. B. controls whether new factories can be built in a nonattainment area. C. is a method for determining total emissions in one area. D. all of the above. Answer: C 3. "Superfund" is a creation of which of the following? A. the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) B. the Occupational Safety and Health Administration (OSHA) C. the National Environmental Policy Act (NEPA) D. the Environmental Protection Agency (EPA) Answer: A 4. What is a principal purpose of the Superfund? A. to establish environmentally-friendly zoning plans B. to establish appropriate eminent domain compensation C. to pay the cost of eliminating or containing condemned waste sites D. to pay the cost of funding environmental impact statements for public projects Answer: C 5. What federal act regulates the federal government in terms of its operations and impact on the environment? A. the Environmental Protection Act B. the National Environmental Policy Act C. the Clean Water Act D. the Resource Recovery Act Answer: B 6. The Endangered Species Act gives which of the following cabinet-level officers the authority to protect various species? A. the Secretary of the Interior only B. the Secretary of Commerce only C. both the Secretary of the Interior and the Secretary of Commerce D. none of the above Answer: C 7. Which federal agency has primary responsibility for enforcing environmental laws? A. the Environmental Protection Agency B. the Council of Environmental Quality C. the Superfund Panel D. none of the above Answer: A 8. Federal environmental laws can be enforced through: A. penalties. B. criminal sanctions. C. suits by private citizens. D. all of the above. Answer: D 9. __________ of the federal environmental laws carry criminal penalties for violations. A. All B. Most C. Very few D. None Answer: B 10. A nuisance: A. is created by every interference that has an effect on others. B. is established when the plaintiff shows harm as the result of the defendant's conduct. C. arises only by an interference that is great enough to be condemned as unreasonable. D. cannot arise from a lawful activity or business that is conducted in a lawful manner. Answer: C 11. With regard to the law concerning nuisance: A. the law recognizes legal remedies for a public, but not private, nuisance. B. the courts do not balance the protection of the plaintiff against the social utility of the activity. C. the fact that the plaintiff suffered annoyance or inconvenience is sufficient to establish a nuisance. D. a finding that conduct is socially desirable may outweigh harm to a particular plaintiff. Answer: D 12. Which of the following is a possible remedy for a nuisance? A. termination by police authority B. injunction C. money damages D. all of the above Answer: D 13. A criminal nuisance may be terminated by: A. abatement. B. closure by government authority. C. abatement or closure by government authority. D. none of the above, since the law only recognizes civil (not criminal) remedies for nuisance. Answer: C 14. The process by which the buyer conducts a thorough investigation of the property and its current and former uses to determine whether there are any problems with respect to environmental law or nuisance is called: A. continuing the nuisance. B. due diligence. C. nuisance per se. D. nuisance per fact. Answer: B 15. Which of the following statements is correct concerning restrictive covenants? A. Restrictive covenants that have not been enforced or observed are nevertheless valid and enforceable. B. Restrictive covenants take precedence over conflicting statutes. C. Restrictive covenants generally impose some limitations on the landowner’s use of the property. D. If any uncertainty exists in the interpretation of a restrictive covenant, the covenant will be interpreted liberally in favor of the limited use of the land. Answer: C 16. Valid restrictive covenants will bind future owners of the land if: A. they are published in the Federal Register. B. there is a notation in the deed referencing the restrictive covenants. C. they are published in a newspaper of general circulation. D. they are filed with the attorney general of the state in which the land is located. Answer: B 17. A zoning restriction: A. constitutes an eminent domain "taking." B. always entitles the landowner to compensation. C. never lowers the value of the land it concerns. D. may prevent the landowner from use of the land. Answer: D 18. When a zoning ordinance is adopted, any existing property used for a purpose that does not conform to the zoning ordinance: A. must be demolished. B. must no longer be used for a nonconforming use or purpose. C. may be used for any use that does not conform to the zoning regulation. D. may continue to be used for the same nonconforming use. Answer: D 19. A nonconforming use: A. that is discontinued for a period of less than thirty (30) days may be resumed. B. has a right to continue for only five (5) years. C. has a constitutionally-protected right to continue. D. that continues for more than one (1) year cannot be lost by abandonment. Answer: C 20. It is probable that a zoning variance would be granted: A. even though many of the neighboring property owners object. B. on the grounds of hardship, regardless of who created the hardship. C. to an outside advertiser to build a billboard. D. when the desired use of the land is in harmony with the general nature of the surrounding areas. Answer: D CASE 1. Megan owns a manufacturing business in a nonattainment area under federal air pollution law. She wishes to triple the size of the manufacturing operation using land she just purchased next to her current location. What must Megan demonstrate in order to secure a permit to operate in the nonattainment area? Answer: Under the Emissions Offset Policy, Megan must show: (1) the new plant will have the greatest possible emissions controls; (2) all other operations are in compliance with federal emission standards; and (3) the new plant's emissions will be offset by reductions in emissions in other facilities. COMMENTS: Note that the effect of this view is to change the prior pattern of issuing building permits, when they were issued as a routine matter so long as the zoning laws were satisfied and a fee was paid. Under this new view, the permit-issuing body must give consideration to the environmental impact statement and exercise discretion in determining whether to issue a building permit. 2. Peter has been subjected to an unreasonable amount of noise from his neighbor, who constantly plays his stereo at full volume. Peter is angry about his neighbor, but he is even angrier about the excessive pollution being emitted by a local factory that burns old tires in direct violation of a state statute prohibiting such conduct. Do the acts of Peter's neighbor and the factory constitute nuisances? If they do, give Peter assistance on any possible courses of action to eliminate the problems. Answer: A nuisance is defined as an unreasonable interference with the enjoyment or use of land. Peter's neighbor is definitely creating a conflict by his excessive stereo volume; however, the harm that Peter sustains would have to be beyond a mere inconvenience or annoyance with his neighbor's actions to be classified as a nuisance. If Peter's neighbor's actions constitute a nuisance, they would be classified as a private nuisance, since only Peter is affected. Peter would be entitled to monetary damages and possibly an injunction or court order. The actions of the factory create a nuisance. More particularly, the actions of the factory would constitute a public nuisance, since they affect not just Peter, but the community or public at large. Once again, monetary damages could be sought. In addition, a court injunction would serve to eliminate the problem. 3. The Jarvis family owned its land for more than 150 years. The Jarvis family traditionally farmed the land and for that purpose maintained farm animals. As years passed, most of the surrounding farms were sold by the owners and the area turned out to be a close-in suburb of a major city. A zoning ordinance was passed that prohibited maintaining a barn or farmyard animals on the land. The Jarvis family was advised that they were unaffected by this ordinance because theirs would be considered a nonconforming use. The members of the Jarvis family lost interest in farming and sold off all their animals. Seven (7) years later, a family member desired to raise a few pigs on the property. Angry neighbors asserted that the family has lost the right to do so. What is your opinion? Answer: Although the Jarvis family originally had the right to maintain animals on the premises, it appears that the nonconforming use was discontinued. This discontinuance for a period of seven (7) years probably constituted an abandonment. The likelihood is that the Jarvis family no longer has the right to raise pigs on the property. Chapter 51—Leases TRUE/FALSE 1. A lease is the relationship by which one person is in lawful possession of real property owned by another. Answer: True 2. The relationship of landlord and tenant is always created by an express contract. Answer: False 3. In almost all states, a periodic tenancy is implied if the tenant, with the consent of the landlord, stays in possession of the property after a tenancy for years. Answer: True 4. When a lease runs for an indefinite period, which may be terminated at any time by the landlord or the tenant, a tenancy at will exists. Answer: True 5. A tenancy by sufferance describes a tenancy that can be terminated at any time upon proper notice. Answer: False 6. Under the common law, the reason a landlord terminates a lease by notice is immaterial. Answer: True 7. A tenancy for years terminates at the expiration of the specified term, regardless of whether one party gives the other any notice of termination. Answer: True 8. A provision in a lease giving the landlord the right to terminate the lease by notice is strictly construed against the tenant. Answer: False 9. If a leased building is destroyed, the lease is not terminated, and the landlord has a duty to restore the building to its former condition. Answer: False 10. Renewal provisions in a lease are strictly construed against the tenant. Answer: True 11. The rights and duties of the landlord and tenant are based on principles of real estate law and contract law. Answer: True 12. Generally, the tenant has the right to the exclusive possession of the premises during the term of the lease. Answer: True 13. Inference occurs when a landlord prevents a tenant from accessing the property. Answer: True 14. The covenant of quiet enjoyment protects the tenant from interference with possession by the landlord or the landlord’s agent, and it also imposes liability on the landlord for the unlawful acts of third persons. Answer: False 15. A tenant can claim that there has been a constructive eviction even if the tenant continues to occupy the rented premises. Answer: False 16. An act or omission of the landlord that substantially deprives the tenant of the use and enjoyment of the premises is a constructive eviction. Answer: True 17. Unless restricted in the lease, a tenant may generally use the premises for any lawful purpose for which they are adapted. Answer: True 18. If the tenant uses the property for any purpose other than the one specified in the lease, the landlord has the option to declare the lease terminated. Answer: True 19. A lease provision requiring a tenant to obey regulations that may be subsequently adopted by the landlord is void because it is unconscionable. Answer: False 20. The assignment of a lease discharges the original tenant from the duty to pay rent. Answer: False 21. In a residential lease, it is commonly held that there is an implied warranty of habitability. Answer: True 22. Making improvements is a duty that falls on the tenant. Answer: False 23. In the absence of an agreement to the contrary, a tenant is not liable for increased taxes imposed on the rented property by a general tax increase. Answer: True 24. A landlord has the right to enter a leased property to make repairs without notifying the tenant. Answer: False 25. A lessor can always refuse to renew the lease of a tenant who reports the landlord to the fire department for violation of fire safety laws. Answer: False 26. Under the common law and the majority rule, a landlord has no duty to mitigate damages when the tenant abandons the premises before the expiration of the lease. Answer: True 27. Ordinarily, the landlord is not liable to the tenant for crimes committed on the premises by third persons, such as when a third person enters the premises and commits larceny or murder. Answer: True 28. A landlord is ordinarily not liable to third persons injured because of the condition (not existing at the time the lease was created) of any part of the rented premises that is in the possession of a tenant by virtue of a lease. Answer: True 29. A tenant in possession has control of the property and is therefore liable when the tenant's failure to use due care under the circumstances causes harm to licensees or invitees. Answer: True 30. A sublease and an assignment of a lease accomplish the same results. Answer: False MULTIPLE CHOICE 1. In a lease agreement, the person who owns the real property and permits the occupation of the premises is known as the __________, and the person who occupies the property is known as the __________. A. lessor; lessee B. lessee; lessor C. grantor; grantee D. grantee; grantor Answer: A 2. Many states provide that a lease for a term exceeding __________ must be in writing. A. three (3) months B. six (6) months C. one (1) year D. three (3) years Answer: C 3. A provision in a residential lease stating that the landlord cutting off heat or water will not constitute an eviction is: A. valid. B. a stipulation. C. a covenant. D. unconscionable. Answer: D 4. A tenancy for an indefinite time period that may be terminated at any time by landlord or tenant is called a tenancy: A. at will. B. for years. C. at sufferance. D. from year to year. Answer: A 5. When a tenant remains in possession after the termination of the lease without permission of the landlord, the landlord may treat the tenant as either a trespasser or a tenant. Until the landlord elects to do one or the other, a tenancy __________ exists. A. at sufferance B. at will C. for years D. from year to year Answer: A 6. When a lease covers rooms or an apartment in a building, a destruction of the leased premises: A. temporarily suspends the tenant’s obligation to pay rent. B. terminates the lease. C. requires the landlord to repair or restore the property. D. has no effect on the obligations of the tenant or the landlord. Answer: B 7. An express promise by a landlord to not disturb the tenant’s possession of the land is known as the covenant of: A. domesticity. B. tranquil possession. C. quiet enjoyment. D. unfettered use. Answer: C 8. A term of a lease required that the landlord provide exterminating services monthly to control rats and other pests. The landlord failed to do this despite numerous requests placed by the tenant, and the premises became overrun by rats. This may be considered: A. a breach of the covenant of quiet enjoyment. B. a physical eviction. C. active waste. D. a constructive eviction. Answer: D 9. If a lease is assigned, who is liable for the rent? A. the assignor B. the assignee C. either the assignor or the assignee, but not both D. the landlord can collect from both the assignor and the assignee Answer: C 10. Rent is automatically increased: A. if the lessor makes expensive improvements to the property. B. when the cost of living increases. C. if the lease contains an escalation clause. D. if the lessor's taxes on the rented property are increased. Answer: C 11. A landlord has the right to enter a leased premises without notice: A. for emergency purposes. B. for repairs and evaluations. C. both a. and b. D. none of the above. Answer: A 12. Igor immigrated to the United States and sought to rent an apartment. He answered an advertisement in a newspaper and signed a lease for an apartment without ever seeing the apartment. Igor found the premises filled with an abundance of debris, rats and insects. Also, the plumbing in the apartment was inoperable. These conditions: A. do not affect the lease unless the landlord affirmatively warranted the condition of the premises. B. are the responsibility of the tenant to repair. C. most likely constitute a breach of the implied warranty of habitability. D. do not entitle Igor to vacate the premises. Answer: C 13. If taxes or assessments on leased premises are increased because of improvements made by the tenant the: A. landlord is only liable for such increases if the improvements stay with the property. B. landlord is liable for such increases whether or not the improvements stay with the property. C. landlord is liable for such increases only to the extent that the improvements actually increase the fair market value of the property. D. tenant is always liable for such increases. Answer: A 14. Which of the following is an example of a legal restriction that may be imposed on a tenant’s deposit? A. A statutory limitation on the amount of the deposit. B. A requirement that the landlord hold the deposit in a trust fund. C. A requirement that the landlord pay interest for the period the deposit is held. D. All of the above. Answer: D 15. If a tenant fails to pay rent on time the landlord: A. has an automatic lien on the tenant’s personal property for the money due. B. has the right to lock the tenant out of the property. C. may take legal steps to evict the tenant. D. all of the above. Answer: C 16. A __________ action restores the property to the landlord’s possession unless the tenant complies with payment requirements. A. forcible entry and detainer B. forcible exit and retainer C. passive entry and detainer D. passive exit and retainer Answer: A 17. A landlord is most likely liable to a tenant who is injured by: A. a defective condition of the leased premises that is under the control of the tenant. B. an obvious condition of the leased premises known to the tenant at the time the lease was made. C. an unforeseeable criminal act of a third person. D. the criminal act of a third person, when such conduct was reasonably foreseeable. Answer: D 18. A provision in a residential lease excusing a landlord from liability for damage caused by water, snow, or ice is __________. A. enforceable B. enforceable, but only in those areas of the United States that are unusually exposed to adverse weather conditions C. void D. voidable Answer: C 19. A tenant in possession has control of the property and is liable when his or her failure to use due care under the circumstances causes harm to: A. invitees. B. licensees. C. trespassers. D. both a. and b. Answer: D 20. In which of the following situations would a third party acquire greater rights than the original lessee? A. an assignment B. a sublease C. a. and b. D. neither a. nor b. Answer: D CASE 1. Arnold Properties, Inc. entered into a lease agreement with Janet for a residential house. Janet made four (4) subsequent monthly payments. At the end of the four (4) months, Janet learned that she was to be transferred to a new job in another state. Janet approached her landlord and explained her situation. The landlord was unsympathetic and refused to release Janet from her rent. The landlord insisted on enforcement of rental payment for the duration of the lease, which was for one (1) year. Janet had not provided for a release in her lease to cover the possibility of a job transfer. Must Janet pay for the remaining eight (8) months of rent even if she is not in physical possession of the property? Answer: It is generally held that if a tenant leaves a leased property before the expiration of the lease, the landlord is under no duty to seek to find a new tenant for the premises. The landlord need not mitigate damages by finding a new renter and can insist on payment under the original lease. In a minority of states, the landlord has a duty to make a reasonable effort to rent abandoned property. Residential leases may provide a provision for termination in the event of a stated occurrence, but such provisions are strictly construed against the tenant. The occurrence of a transfer should have been addressed in Janet's lease for her to be able to legally terminate the lease. 2. Morris rented an apartment in a relatively safe neighborhood of a major city. The door to Morris' apartment had two locks, and one of these was of the deadbolt variety designed to prevent burglaries. Morris left for work and engaged both locks. When Morris returned from work, Morris found that a burglar had broken into the apartment by forcibly breaking the locks. Morris sustained a substantial loss of money and property from this burglary. Morris notified the building superintendent and the owner who had the locks repaired. The attempted repairs were not entirely successful, inasmuch as the locks did not properly lock on some occasions. This enabled the door to be readily opened whenever anyone pushed against the door. Morris complained frequently about the condition of the locks, but the owner would take no further action regarding them. Finally, a burglar again broke into Morris' apartment, stealing substantial sums. This time, there was no breaking of the locks. The evidence was that the locks were not working properly at the time of the burglary. Morris sued the owner for the losses from the two burglaries. Decide. Answer: Generally, a landlord is not liable for crimes committed on the premises by third persons. Applying this rule, the landlord is not responsible for the first loss. When the criminal acts of third persons are foreseeable, however, the landlord may be held responsible for not taking reasonable steps to prevent loss to the tenant. Before the second burglary, Morris had complained about the defective condition of the locks on the door. The failure to fix the locks may result in landlord liability for the second burglary. 3. Roberts leased a duplex from Hughes. Later, without Hughes' knowledge, Roberts sublet half of the duplex to Carrera. Carrera did not take proper care of the premises and her part of the duplex was substantially damaged as a result of her negligent use and abuse. Upon discovering the situation, Hughes notified Roberts that he was holding him responsible for any and all damages to Carrera's portion of the duplex, and that Roberts was to bear the costs of returning the premises to the original state of repair. Roberts replied that he had sublet to Carrera in good faith, had no further dealings with Carrera after the sublet agreement, had no knowledge of negligence, and could not be held liable for damages caused by another. Can Roberts be held liable? Answer: Yes. Roberts is liable. In the absence of an express covenant or promise to the contrary, the holder of the original lease does not escape liability through the act of subletting a portion of the lease. Chapter 52—Decedents' Estates and Trusts TRUE/FALSE 1. The debts of a decedent are paid prior to distribution of any balance of the estate to those entitled to receive it. Answer: True 2. Testate distribution describes the distribution that is made when the decedent leaves an invalid will. Answer: False 3. A beneficiary of personal property by will may be called a devisee. Answer: False 4. Generally, the right to make a will is limited to persons 18 or older. Answer: True 5. To make a valid will, the testator must have testamentary capacity. Answer: True 6. Testamentary intent makes the provisions of the testator effective and binding during the testator's life. Answer: False 7. A will is very informal and may be created in any reasonable manner. Answer: False 8. A written will must be signed by the testator at the bottom or end of the will. Answer: True 9. Statutes often require that the attestation of witnesses be made in the presence of the testator and in the presence of each other. Answer: True 10. A will, to be effective, always must be dated. Answer: False 11. A will cannot be modified by merely crossing out a clause and writing in something new. Answer: True 12. A will may only be revoked by operation of law; it may not be revoked by act of the testator. Answer: False 13. A holographic will is an unwitnessed will that is written by the testator entirely by hand. Answer: True 14. A living will, now legal in most states, provides that if the testator becomes unable to express his or her wishes and is in an irreversible, incurable medical condition, he or she does not want life-sustaining medical treatments. Answer: True 15. The judge, not the decedent, has the privilege of naming who is to administer the estate of a person who has died with a will. Answer: False 16. One desiring to leave the balance of an estate to a specified person or group after specific bequests are satisfied may do so by making a residuary bequest in a will. Answer: True 17. When specifically bequeathed property is sold or given away by the testator prior to death, the bequest is considered “redeemed.” Answer: False 18. Antilapse statutes commonly provide that the gift to the deceased beneficiary shall not lapse but that the children or heirs of that beneficiary may take the legacy in the place of the deceased beneficiary. Answer: True 19. Under the Uniform Simultaneous Death Act, if survivorship cannot be established, the property of each person is disposed of as though each had survived the other. Answer: True 20. If a trust is created to take effect within the lifetime of the settlor, it is a testamentary trust. Answer: False 21. The requirements to create a trust are uniform. Answer: False 22. A trust is invalid if a beneficiary lacks capacity. Answer: False 23. A failure by the settlor to name a trustee renders a trust invalid. Answer: False 24. Every trust must have a beneficiary. Answer: True 25. When property is transferred to a trust, the trustee has legal title and the beneficiary has equitable title. Answer: True 26. A trustee cannot make decisions on matters that could not be foreseen by the settlor. Answer: False 27. A trustee can delegate the performance of personal duties. Answer: False 28. A trustee is not permitted to profit personally from the position of trustee, other than to receive the compensation allowed by contract or law. Answer: True 29. A trustee may keep all matters associated with the trust secret. Answer: False 30. A trust may be terminated by its own terms. Answer: True MULTIPLE CHOICE 1. Which of the following is generally not required for the testator to have testamentary capacity? A. The testator knows the exact value of his or her estate. B. The testator understands the writing to be a will. C. The testator has a reasonable appreciation of the identity of relatives and friends. D. The testator has a reasonable appreciation of the extent of the property that may exist at death. Answer: A 2. An individual who desires to make provisions that will be effective only on his or her death is said to have: A. probationary intent. B. a prejudicial interest. C. testamentary intent. D. attestation intent. Answer: C 3. Unless statutory requirements are met, a will is invalid and the testator: A. is considered to have died testate. B. is considered to have died intestate. C. is subject to federal law. D. has provided guidelines of distribution. Answer: B 4. Which of the following is not a correct statement concerning wills? A. Attestation is the act of witnessing the execution of a will. B. Most states require two (2) witnesses to the execution of the will. C. A will must be dated. D. Self-proved wills are wills that carry a presumption that they are valid if executed according to the requirements set forth by statute. Answer: C 5. A codicil: A. must be executed with the same formalities as a will. B. is treated the same as a will. C. does not invalidate the entire will. D. all of the above. Answer: D 6. Where a testatrix executes a will and later has a child: A. the child is prohibited by law from receiving anything from the estate. B. many states hold that the will of the testatrix is partially revoked by operation of law to provide a share to the after-born child. C. a new will must be executed because the birth voids the original will. D. the after-born child takes a share by escheat. Answer: B 7. Probate is the act by which: A. the court declares an instrument is a valid will. B. a qualified person may contest the will. C. the witnesses sign an attestation clause. D. publication of the will takes place. Answer: A 8. A will may be contested on grounds of: A. lack of mental capacity of the testator. B. undue influence, duress, or mistake. C. forgery. D. all of the above. Answer: D 9. Letters testamentary: A. are given to an administrator. B. are given to an executor. C. require a bond to be filed by the person to whom they are given if the will exempts the requirement. D. none of the above. Answer: B 10. When a testator provides for a bequest of his gold watch to his nephew, but the gold watch is not owned by the testator at the time of death: A. the nephew is entitled to an equivalent amount of cash. B. the executor must purchase a similar gold watch for the nephew if funds are available. C. the bequest to the nephew fails by ademption. D. all legacies in the estate abate to provide funds to purchase a gold watch for the nephew. Answer: C 11. A bequest of a pearl necklace is a: A. general legacy. B. specific legacy. C. specific ademption. D. residuary ademption. Answer: B 12. The relatives of an individual who dies without a valid will may acquire title to the decedent's property through: A. intestate succession. B. the right of replevin. C. testate succession. D. the right of acquisition. Answer: A 13. State intestacy statutes commonly provide for distribution in the following order: A. spouse, parents, lineals, collateral heirs. B. spouse, lineals, collateral heirs, parents. C. spouse, lineals, parents, collateral heirs. D. spouse, lineals, collateral heirs, parents,. Answer: C 14. When distributees stand in different degrees of relationship: A. distribution is made per stirpes. B. distribution is made per capita. C. a distribution cannot be made without the consent of the state. D. the right of escheat applies. Answer: A 15. In order for a trust to be created, who must be able to hold legal title? A. the beneficiary only B. the trustee only C. either the beneficiary or the trustee D. both the beneficiary and the trustee Answer: B 16. A decedent's transfer of $10,000 to a trustee, to be held in trust for A, will fail to create a valid trust if: A. it was not supported by consideration. B. the trustee lacks capacity. C. A is not a family member of the decedent. D. the trustee had no opportunity to renounce the trust. Answer: B 17. Which of the following is an incorrect statement concerning trusts? A. The trustee has legal title to the corpus. B. The beneficiary has equitable title to or beneficial interest in the corpus. C. Generally, a beneficiary may not transfer his or her interest in the trust. D. A trustee cannot delegate the performance of personal duties. Answer: C 18. Which of the following is not a duty of a trustee? A. to use reasonable skill B. to keep accurate records C. to invest trust assets D. to deliver possession of trust assets to the settlor for the trust period Answer: D 19. If the trustee breaches the trust, which of the following remedies might be available? A. a money judgment B. an injunction C. a criminal prosecution D. all of the above Answer: D 20. A trust may be terminated: A. by its own terms. B. by merger of all interests in the same person. C. via revocation by the settlor if allowed by the terms of the trust. D. all of the above. Answer: D CASE 1. Fred and Mary were married. Fred had executed a will prior to the marriage that left all of his property, both real and personal, to his mother. Fred later died without changing his will. Mary feels that she should be entitled to some of Fred's estate. While waiting for Fred's estate to be finalized, Mary remarries. Mary's second husband executes a will providing for Mary. Later, after Mary and her husband adopt two children, her second husband dies. Mary feels that her children should be entitled to receive something from her second husband's estate. Is Mary and, later, are her adopted children entitled to receive something under the wills? Answer: Yes. Under certain circumstances statutes provide that a change in circumstances has the effect of a revocation or a partial revocation of a will. When a person marries after a will already has been executed, that person often is entitled to a share of the estate. The amount of the share varies from state to state. It also is commonly provided that the adoption of a child or children after the execution of a will works a partial or full revocation as to those children. Again, the amount of the estate to which the children are entitled varies from state to state. 2. Tuttle died at age 96, leaving a will that she made at age 40 that provided that her three children would share her estate equally. At the time of her death, only one child, Anna, was living. Tuttle's two deceased children, Bill and Caroline, each had two children who were living at the time of Tuttle's death. Anna is claiming that she is entitled to the entire estate because the bequests to Bill and Caroline lapsed upon their deaths prior to Tuttle's death. How will the estate be settled? Answer: The bequests to Bill and Caroline will not lapse. There are antilapse statutes that commonly provide that gifts to deceased beneficiaries, instead of lapsing, will be given to the children of such beneficiaries. Thus, the beneficiaries under Tuttle's will are Anna, Bill's two children, and Caroline's two children. Because the five beneficiaries are of different generations, distribution will be per stirpes. Anna will be entitled to one-third of the estate, Bill's two children will split one-third, and Caroline's two children will split the remaining one-third. 3. Margo had only one son, and her husband had predeceased her. The son was reckless and extravagant, but Margo loved him dearly. She left all her property to a trustee in trust for her son and provided that the trust was a spendthrift trust. Margo further provided that the income from the trust was to be paid to her son quarterly until he reached the age of 30 at which time the full trust corpus was to be paid over to him. After Margo's death and before the son had reached the age of 30, the son signed a contract that purported to transfer the entire trust corpus to a finance company. The son was paid for this. The son had also run up many unpaid bills on which he was sued and judgments entered against him. The finance company and the other judgment creditors are seeking to compel the trustee to turn over the trust corpus to them. Decide. Answer: Where the settlor provides that the trust is a spendthrift trust, the beneficiary cannot transfer his or her interest to anyone. Likewise, creditors cannot reach the interest in such a trust. The name "spendthrift" provides a clue regarding the nature of this type of trust that is designed to protect a spendthrift from defeating the wishes of the settlor. Test Bank for Business Law: Principles for Today's Commercial Environment David P. Twomey, Marianne M. Jennings 9781133588245, 9781305575158, 9780324786699
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