Business Law on the CPA Exam: Contracts, Agency, and More

Business law makes up a significant portion of the REG section, and it often catches candidates off guard. While many REG study plans focus heavily on taxation, business law questions can easily make the difference between passing and failing. The topics are conceptual rather than computational, which means they require a different study approach. You need to understand legal principles, distinctions between frameworks, and how rules apply in specific scenarios. This article covers the core business law topics tested on the CPA exam, including contracts, the UCC, agency relationships, debtor-creditor law, secured transactions, and bankruptcy.

Contract Formation

A valid contract requires four elements, and the exam tests all of them:

Agreement (Offer and Acceptance) - There must be a valid offer by one party and an acceptance by another. The offer must be definite and communicated to the offeree. Acceptance must be unequivocal and communicated to the offeror.
Consideration - Each party must give something of legal value. Past consideration is not valid consideration. A promise to do something one is already legally obligated to do (pre-existing duty rule) is generally not valid consideration.
Capacity - Both parties must have the legal capacity to contract. Minors, mentally incapacitated persons, and intoxicated persons may lack capacity. Contracts with minors are generally voidable at the minor's option.
Legality - The purpose of the contract must be legal. Contracts for illegal activities are void and unenforceable.

Additional Contract Concepts

Several related concepts are frequently tested:

Statute of Frauds - Certain contracts must be in writing to be enforceable, including contracts for the sale of goods $500 or more (UCC), contracts for the sale of real property, contracts that cannot be performed within one year, promises to answer for the debt of another (suretyship), and contracts in consideration of marriage. The mnemonic MY LEGS (Marriage, Year, Land, Executor, Goods $500+, Surety) helps remember these.
Parol Evidence Rule - When parties have a written contract intended as a complete and final expression of their agreement, evidence of prior or contemporaneous oral or written agreements that contradict the written contract is generally inadmissible.
Mailbox Rule - An acceptance is effective when dispatched (mailed), while a rejection is effective when received. If an offeror specifies a method of acceptance, that method must be used.

UCC vs. Common Law

One of the most important distinctions in business law is whether a transaction is governed by the Uniform Commercial Code (UCC) Article 2 or the common law. The general rule is:

UCC Article 2 applies to transactions involving the sale of goods (tangible, movable personal property).
Common law applies to transactions involving services, real estate, and intangible property.

When a contract involves both goods and services, the predominant purpose test applies: whichever element predominates determines which body of law governs.

Key Differences Between UCC and Common Law

Offer firmness - Under common law, an offer can be revoked at any time before acceptance (unless supported by consideration, making it an option contract). Under the UCC, a merchant's firm offer is irrevocable for up to three months without consideration.
Acceptance - Under common law, the mirror image rule applies: acceptance must match the offer exactly. Under the UCC, acceptance can include additional or different terms (the "battle of the forms" under Section 2-207).
Consideration for modification - Common law requires consideration to modify a contract. The UCC allows modification without consideration if made in good faith.
Statute of Frauds threshold - The UCC requires a writing for the sale of goods priced at $500 or more. Common law has different thresholds depending on the type of contract.

Agency Relationships

An agency relationship exists when one person (the agent) is authorized to act on behalf of another (the principal). The exam tests several aspects of agency law:

Formation

An agency relationship can be created by agreement, ratification, estoppel, or operation of law. No consideration is required, and the relationship can be oral (except when the Statute of Frauds requires a writing, such as when the agent is authorized to sell real property).

Types of Authority

Actual authority - Authority expressly or impliedly granted by the principal. Express authority is directly communicated. Implied authority is reasonably necessary to carry out express authority.
Apparent authority - Authority that a third party reasonably believes the agent possesses based on the principal's representations or conduct, even if the agent does not actually have that authority.

Liability

Disclosed principal - The principal is liable on contracts entered into by the agent within the scope of authority. The agent is generally not liable.
Partially disclosed principal - Both the principal and agent may be liable.
Undisclosed principal - Both the principal and agent are liable, and the third party can choose to hold either one responsible.

Duties

The agent owes fiduciary duties to the principal, including loyalty, obedience, reasonable care, accounting, and notification. The principal owes the agent compensation (if agreed), reimbursement, and indemnification.

Debtor-Creditor Relationships

The exam tests several concepts related to debtor-creditor law:

Suretyship and Guaranty

A surety is a party who promises to pay the debt of another if the debtor defaults. A surety is primarily liable (the creditor can go directly to the surety without first pursuing the debtor). A guarantor is secondarily liable and can invoke the defense of collection, requiring the creditor to pursue the debtor first.

Surety defenses include:

Payment or performance by the debtor
Release of the surety by the creditor
Material modification of the obligation without the surety's consent
Fraud or duress by the creditor against the surety
Statute of limitations

Defenses that are not available to the surety include: the debtor's incapacity, the debtor's discharge in bankruptcy, and the debtor's claim of statute of limitations.

Secured Transactions (UCC Article 9)

Secured transactions involve a creditor who has a security interest in the debtor's personal property (collateral). The three key concepts are:

Attachment - The security interest becomes enforceable against the debtor. Requirements: (1) value given by the creditor, (2) the debtor has rights in the collateral, and (3) a security agreement authenticated by the debtor describing the collateral.
Perfection - The security interest becomes enforceable against third parties. The most common method is filing a financing statement (UCC-1). Other methods include possession, control, and automatic perfection (for purchase money security interests in consumer goods).
Priority - When multiple creditors claim the same collateral, priority rules determine who gets paid first. Generally: perfected interests beat unperfected interests, and among perfected interests, first to file or perfect wins. A purchase money security interest (PMSI) has special priority rules.

Bankruptcy Basics

Bankruptcy law is tested at a conceptual level on the CPA exam. The main chapters you should know are:

Chapter 7: Liquidation

Available to individuals and businesses.
A trustee collects and liquidates the debtor's nonexempt assets and distributes proceeds to creditors.
Individuals receive a discharge of most debts. Certain debts are nondischargeable, including student loans (absent undue hardship), recent taxes, child support, alimony, and debts obtained by fraud.
The means test determines whether an individual debtor is eligible for Chapter 7 or must file under Chapter 13.

Chapter 11: Reorganization

Primarily used by businesses to reorganize and continue operations.
The debtor typically remains in possession and operates the business as a "debtor in possession."
A plan of reorganization must be proposed and accepted by creditors and confirmed by the court.

Chapter 13: Individual Debt Adjustment

Available only to individuals with regular income.
The debtor proposes a plan to repay creditors over three to five years.
The debtor retains property but must commit disposable income to the plan.

Key Bankruptcy Concepts for the Exam

Automatic stay - Filing for bankruptcy automatically stays (stops) most collection actions against the debtor.
Preferential transfers - Payments to creditors within 90 days before filing (one year for insiders) may be avoided by the trustee.
Fraudulent transfers - Transfers made with intent to hinder, delay, or defraud creditors, or transfers for less than reasonably equivalent value when the debtor was insolvent, can be avoided.
Priority of claims - Secured claims are satisfied first from their collateral. Among unsecured claims, certain categories have priority: domestic support obligations, administrative expenses, wages (up to a limit), employee benefit plans, and tax claims.

Exam Weight and Study Strategy

Business law represents a meaningful portion of the REG section, and the questions tend to be conceptual rather than computational. This means:

You cannot calculate your way to the right answer. You must understand the legal principles.
Read questions carefully for specific facts that trigger specific rules (such as whether the transaction involves goods or services, or whether the party is a merchant).
Focus on the distinctions: UCC vs common law, surety vs guarantor, attachment vs perfection, Chapter 7 vs Chapter 11 vs Chapter 13.
Use practice questions to learn how the exam tests these concepts. The patterns become recognizable with practice.

Think CPA offers REG practice that covers business law topics with the same level of detail and scenario-based questioning you will see on the exam. Integrating business law practice into your study plan, rather than saving it for the end, gives you the best chance of mastering this material before exam day.