J. Karry

Maker Reference: Sale of Lathe

Invoice #6734

4Q-20

On March 10, 1992, Friendly delivered Karry's promissory note, without endorsement, to Queen Bank in exchange for $750. Queen, a holder in due course, was unaware that Karry had advised Friendly that the lathe was not operating properly and that Karry had no intention of paying the note. Queen then delivered the note to Abcor Factors, Inc. in exchange for $800. At the time Abcor acquired the note from Queen, it knew that Karry disputed any obligation under the note because the lathe was not working properly.

Friendly has experienced serious financial difficulties and defaulted on its obligations to Rustic and National. Abcor has demanded that Karry pay the note given to Friendly, but Karry has refused to do so.

Rustic and Karry have taken the following positions:

x Rustic claims that its security interest in the lathes, including the one sold to Karry, is superior to that of National and that Karry purchased the lathe subject to Rustic's security interest.

x Karry refuses to honor the note held by Abcor claiming that:

It is nonnegotiable because it is not payable at a definite time and it references the sales invoice.

Abcor has no rights under the note because it was not endorsed by Friendly.

Abcor was aware of Karry's claim that the lathe was not working properly and, therefore, took the note subject to that claim.

Required:

State whether the claims of Rustic and Karry are correct and give the reasons for your conclusions.

4Q-21

NUMBER 6

River Oaks is a wholesale distributor of automobile parts. River Oaks received the promissory note shown below from First Auto, Inc., as a security for payment of a $4,400 auto parts shipment. When River Oaks accepted the note as collateral for the First Auto obligation, River Oaks was aware that the maker of the note, Hillcraft, Inc., was claiming that the note was unenforceable because Alexco Co. had breached the license agreement under which Hillcraft had given the note. First Auto had acquired the note from Smith in exchange for repairing several cars owned by Smith. At the time First Auto received the note, First Auto was unaware of the dispute between Hillcraft and Alexco. Also, Smith, who paid Alexco $3,500 for the note, was unaware of Hillcraft's allegations that Alexco had breached the license agreement.

PROMISSORY NOTE

Date: 1/14/90

Hillcraft, Inc. promises to pay to Alexco Co. or bearer the sum of $4,400 Four Thousand and 00/100 Dollars on or before May 15, 1991 (maker may elect to extend due date by 30 days) with interest thereon at the rate of 9½% per annum.

Hillcraft, Inc.

By: P.J. Hill

P.J. Hill, President Reference: Alexco Licensing Agreement

The reverse side of the note was endorsed as follows:

Pay to the order of First Auto without recourse E. Smith

E. Smith

Pay to the order of River Oaks Co.

First Auto

By: G. First G. First, President

First Auto is now insolvent and unable to satisfy its obligation to River Oaks. Therefore, River Oaks has demanded that Hillcraft pay $4,400, but Hillcraft has refused, asserting:

x The note is nonnegotiable because it references the license agreement and is not payable at a definite time or on demand.

x River Oaks is not a holder in due course of the note because it received the note as security for amounts owed by First Auto.

x River Oaks is not a holder in due course because it was aware of the dispute between Hillcraft and Alexco.

x Hillcraft can raise the alleged breach by Alexco as a defense to payment.

x River Oaks has no right to the note because it was not endorsed by Alexco.

x The maximum amount that Hillcraft would owe under the note is $4,000, plus accrued interest.

Required: State whether each of Hillcraft's assertions are correct and give the reasons for your conclusions.

4Q-22

NUMBER 7

Prince, Hall, & Charming, CPAs, has been retained to examine the financial statements of Hex Manufacturing Corporation. Shortly before beginning the examination for the year ended December 31, 1986, Mr. Prince received a telephone call from Hex's president indicating that he thought some type of embezzlement was occurring because the corporation's cash position was significantly lower than in prior years. The president then requested that Prince immediately undertake a special investigation to determine the amount of embezzlement, if any.

After a month of investigation, Prince uncovered an embezzlement scheme involving collusion between the head of payroll and the assistant treasurer. The following is a summary of Prince's findings:

x The head of payroll supplied the assistant treasurer with punched time cards for fictitious employees. The assistant treasurer prepared invoices, receiving reports, and purchase orders for fictitious suppliers. The assistant treasurer prepared checks for the fictitious employees and suppliers which were signed by the treasurer. Then, either the assistant treasurer or the head of payroll would endorse the checks and deposit them in various banks where they maintained accounts in the names of the fictitious payees. All of the checks in question have cleared Omega Bank, the drawee.

x The embezzlement scheme had been operating for 10 months and more than $120,000 had been embezzled by the time the scheme was uncovered. The final series of defalcations included checks payable directly to the head of payroll and the assistant treasurer. These checks included skillful forgeries of the treasurer's signature that were almost impossible to detect. This occurred while the treasurer was on vacation. These checks have also cleared Omega Bank, the drawee.

Required:

Answer the following, setting forth reasons for any conclusions stated.

Will Hex or Omega bear the loss with respect to the following categories of checks:

a. those which were signed by the treasurer but payable to fictitious payees?

b. those which include the forged signature of the treasurer?

4Q-23

NUMBER 8

On October 30, 1995, Dover, CPA, was engaged to audit the financial records of Crane Corp., a tractor manufacturer. During the review of notes receivable, Dover reviewed a promissory note given to Crane by Jones Corp., one of its customers, in payment for a tractor. The note appears below.

(Face) (Back)

July 18, 1995 Sixty (60) days from date, the undersigned promises to

Pay to the order of Jones Corp.____________

Twenty Thousand and 00/100 ($20,000……dollars at West Bank

OVAL CORP.