978-0077733735 Chapter 16 Lecture Notes

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Solution Manual

Book Title

Business Law with UCC Applications 14th Edition

ISBN 13

978-0077733735

978-0077733735 Chapter 16 Lecture Notes

April 10, 2019

Chapter 16 - The Nature of Negotiable Instruments

Chapter 16

The Nature of Negotiable Instruments

I. Key Terms

Acceptance (p. 384) Holder (p. 388)

Acceptor (p. 388) Holder in due course (p. 388)

Allonge (p. 392) Indorsee (p. 388)

Assignment (p. 391) Indorsement in full (p. 394)

Bank draft (p. 386) Indorser (p. 388)

Bearer (p. 388) Installment note (p. 383)

Bearer paper (p. 391) International bill of exchange (p. 384)

Bill of exchange (p. 383) Issuer (p. 388)

Blank indorsement (p. 392) Maker (p. 388)

Cashier’s check (p. 386) Money order (p. 387)

Certificate of deposit (CD) (p. 383) Negotiable instrument (p. 382)

Certified check (p. 386) Negotiation (p. 391)

Check (p. 384) Note (p. 383)

Comakers (p.388) Order paper (p. 391)

Conditional indorsement (p. 395) Payee (p. 388)

Conversion (p. 396) Qualified indorsement (p. 395)

Demand note (p. 383) Restrictive indorsement (p. 3594

Dishonored (p. 396) Sight draft (p. 384)

Domestic bill of exchange (p. 384) Special indorsement (p. 394)

Draft (p. 383) Teller’s check (p. 386)

Drawee (p. 388) Time draft (p. 384)

Drawer (p. 388) Trade acceptance (p. 384)

Foreign draft (p. 384) Traveler’s check (p. 346)

II. Learning Objectives

1. State the purpose of a negotiable instrument.

2. Explain those negotiable instruments that contain a promise to pay money.

3. Explain those negotiable instruments that contain an order to pay money.

4. Differentiate among the different types of checks and money orders.

5. Identify the requirements of a negotiable instrument.

6. Explain an assignment and a negotiation of an instrument.

7. Name and describe four kinds of indorsements.

8. Identify the implied warranties related to indorsements.

9. Explain the contract that is made when people indorse negotiable instruments.

10. Describe the legal effect of a forged indorsement.

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Chapter 16 - The Nature of Negotiable Instruments

III. Major Concepts

16-1 The Essentials of Negotiable Instruments

The law of negotiable instruments is found in Article 3 of the UCC. Under the UCC, a

negotiable instrument is a written document signed by the maker that contains an

unconditional promise or order to pay a fixed amount of money on demand or at a

definite time to the bearer or to order. There are two basic kinds of negotiable

instruments: promise instruments (including notes and certificates of deposit) and order

instruments (including drafts and checks). The following are parties to negotiable

instruments: maker or comaker; drawer; issuer; drawee; payee; bearer; holder; holder in

due course; indorser; indorsee; and acceptor. To be negotiable, instruments must: (1) be in

writing; (2) be signed by the maker or drawer; (3) contain an unconditional promise or

order to pay; (4) be made out for a fixed amount of money; (5) be payable on demand or

at a definite time; and (6) except for checks, be payable to order or to bearer.

16-2 Transferring Negotiable Instruments

When an instrument is first delivered by the maker or drawer for the purpose of giving

rights to any person, it is said to be issued. When the person to whom it is issued delivers

it to a third party, it is transferred. Instruments can be transferred by assignment or by

negotiation. An instrument is indorsed when the holder signs it, thereby indicating the

intent to transfer ownership to another. Indorsements may be written in ink, typewritten,

or stamped with a rubber stamp. There are four commonly used types of indorsements:

blank indorsements, special indorsements, restrictive indorsements, and qualified in-

dorsements. Indorsements have threefold significance. In addition to being necessary to

negotiate order paper, they create obligations on the part of the indorser. These obli-

gations come in the form of implied warranties and a contractual promise to pay

subsequent holders of the instrument. An unauthorized signature or indorsement is one

made without actual, implied, or apparent authority.

IV. Outline

I. Purpose and Types of Negotiable Instruments (16-1)

A. Introduction

1. The law of negotiable instruments developed to meet the need of transacting business

without carrying around large sums of money and to facilitate the borrowing of

money.

2. Checks, drafts, and notes are used as a substitute for money and to obtain credit.

3. Online payments are being used as a substitute for checks.

B. Promise and Order Instruments

1. The law of negotiable instruments is found in Article 3 of the UCC.

2. A negotiable instrument is a written document signed by the maker containing an

unconditional promise or order to pay a fixed amount of money on demand or at a

definite time to the bearer or to order.

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Chapter 16 - The Nature of Negotiable Instruments

3. The two basic types of negotiable instruments are promise instruments and order

instruments.

4. A note is a written promise by one party, the maker, to pay money to the order of

another party, the payee.

5. A demand note is payable whenever the payee demands payment.

6. A time note is payable at some future date, on a date named in the instrument.

7. In an installment note the principal and interest on the unpaid balance is payable in

installments at specified times.

8. A certificate of deposit, CD, is an instrument containing an acknowledgment that a

bank has received a sum of money and a promise by the bank to repay the sum of

money.

9. A CD is a note of the bank.

10. In contrast to notes, which are promises to pay money, drafts are orders to pay money.

11. The one who draws the draft is called the drawer.

12. The one who is ordered to pay the money is called the drawee.

13. The one who is to receive the money is known as the payee.

14. Drawees are liable on drafts only when they accept them; that is, agree to become

liable on them.

15. A sight draft is payable as soon as it is presented to the drawee for payment.

16. A time draft is not payable until the lapse of a particular time period stated on the

draft.

17. A domestic bill of exchange is a draft that is drawn and payable in the Untied States.

18. A draft that is drawn in one country but payable in another is called an international

bill of exchange or foreign draft.

19. A check is a draft drawn on a bank and payable on demand.

20. Ownership of a check may be transferred to another person by indorsement by the

payee.

21. A bank must honor a check when it is properly drawn against a credit balance of the

drawer, and failure to do so makes the bank liable to the drawer for damages.

22. While banks provide regular and special printed check forms, the use of a printed

form is not required.

23. A certified check is a check accepted by the bank on which it is drawn; and once a

check is certified, the drawer is discharged from liability.

24. A bank draft, sometimes called a teller’s or treasurer’s check, is a check drawn by one

bank on another bank in which it has funds on deposit in favor of a third person, the

payee.

25. A cashier’s check is a check drawn by a bank upon itself.

26. A traveler’s check is similar to a cashier’s check in that the issuing financial

institution is both the drawer and the drawee.

27. To cash a traveler’s check, the purchaser writes the name of the payee in the space

provided and countersigns it in the payee’s presence.

28. A money order is a type of draft drawn on the funds of the organization that issues it.

C. Parties to Negotiable Instruments

1. A maker is the person who signs a note.

2. A drawer is a person who signs a draft.

3. An issuer is either a maker or a drawer.

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Chapter 16 - The Nature of Negotiable Instruments

4. A drawee is a person ordered in a draft to make payment.

5. A payee is a person to whom a note or draft is payable.

6. A bearer is a person who is in possession of a negotiable instrument that is payable to

bearer or to cash or that has been indorsed in blank.

7. A holder is a person who is in possession of a negotiable instrument that is issued or

indorsed to that person’s order or to bearer.

8. A holder in due course is a holder who is treated as favored and is given immunity

from certain defenses.

9. An indorser is a person who indorses a negotiable instrument.

10. An indorsee is a person to whom a draft or note is transferred by indorsement.

11. An acceptor is a drawee of a draft who has promised to honor the draft as presented

by signing it on its face.

D. Requirements of Negotiable Instruments

1. Written Instrument

a. A negotiable instrument must be in writing.

b. Under the Uniform Electronic Transactions Act, an electronic record fulfills the

requirement of a writing.

c. Article 3 of the UCC has been amended to permit electronic negotiable

instruments although not all states have adopted the amendment.

d. If forgery should happen, the person who drew the instrument would be

responsible for any loss caused by the negligent drawing of the instrument.

2. Signature of Maker or Drawer

a. The instrument must be signed by the maker or drawer.

b. Any writing, mark or symbol is accepted as a signature so long as it expresses the

writer’s intent to make a signature.

c. A signature may be made by an agent or other representative.

d. Agents who sign their own names are personally obligated if the instrument

neither names the person represented nor shows that the agent signed in a

representative capacity.

3. Unconditional Promise or Order to Pay

a. The instrument must contain no conditions that might in any way affect its

payment.

b. Statements requiring that certain things be done or that specific events take place

prior to payment make the instrument a simple contract rather than negotiable

paper.

c. In addition to being unconditional, a negotiable instrument must contain a

promise to pay or an order to pay.

4. Fixed Amount of Money

a. A negotiable instrument must be payable in a fixed amount or a sum certain of

money.

b. Money is defined as a medium of exchange adopted by a domestic or foreign

government as part of its currency.

5. Payable on Demand or at a Definite Time

a. Negotiable instruments must be made payable on demand or at a definite time.

b. An instrument is payable on demand when it so states, or when it is payable “on

sight” or “on presentation.”

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Chapter 16 - The Nature of Negotiable Instruments

c. Instruments payable at a fixed period after a stated date or at a fixed period after

sight are considered payable at a definite time.

6. Payable to Order or to Bearer

a. Negotiable instruments, except for checks in states that have adopted revised

Article 3, must be payable to order or to bearer.

b. The terms to the order of and to bearer are called words of negotiability.

7. Dates and Controlling Words

a. The omission of a date does not affect the negotiability of an instrument.

b. When the date is omitted, the date on which the instrument is received is

considered to be the date of its issue.

c. Handwritten terms control typewritten and printed terms, typewritten terms

control printed terms, and words control figures except when words are

ambiguous.

II. Transferring Negotiable Instruments (16-2)

A. Introduction

1. Instruments can be transferred by assignment or by negotiation.

2. An assignment is the transfer of a contract right from one person to another.

3. Negotiable instruments are assigned either when a person whose indorsement is

required on an instrument transfers it without indorsing it or when it is transferred to

another person and does not meet the requirements of negotiability.

4. In the case of an assignment, the transferee has only the rights of an assignee and is

subject to all defenses existing against the assignor.

5. A negotiation is the transfer of an instrument in such form that the transferee becomes

a holder.

6. To be negotiated, order paper must be indorsed by the payee and delivered to the

party to whom it is transferred; but bearer paper may be negotiated by delivery alone.

B. The Concept of Negotiability

1. The person receiving a negotiable instrument is provided with additional protection

and in many cases is able to recover money on the instrument even when the person

from whom the instrument was received could not have done so.

2. Instruments that do not meet the requirements of negotiability can be transferred by

assignment which is governed by contract law.

3. People who receive instruments by assignment are not given the special protection

provided those who receive instruments by negotiation because they cannot be

holders in due course.

C. Negotiation by Indorsement (27-3)

1. Blank Indorsements

a. A blank indorsement consists of the signature alone written on the instrument.

b. When an instrument is indorsed in blank, it becomes payable to bearer and may

be transferred by delivery alone.

2. Special Indorsements

a. A special indorsement is made by writing the words pay to the order of or pay to

followed by the name of the person to whom it is to be transferred and the

signature of the indorser.

b. The instrument remains an order instrument and must be indorsed by the indorsee

before it can be further negotiated.

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Chapter 16 - The Nature of Negotiable Instruments

3. Restrictive Indorsements

a. A restrictive indorsement limits the rights of the indorsee in some manner in order

to protect the rights of the indorser.

b. Indorsements for deposit or collection are restrictive indorsements designed to get

an instrument into the banking system for the purpose of deposit or collection.

c. A conditional indorsement, a type of restrictive indorsement, makes the rights of

the indorsee subject to the happening of a certain event or condition.

d. A person paying an instrument with a conditional indorsement or taking it for

value may disregard the condition.

4. Qualified Indorsements

a. A qualified indorsement occurs when words have been added to the signature

limiting the liability of the indorser.

b. By adding the words without recourse to the indorsement, the indorser is not

liable in the event the instrument is dishonored.

D. Obligations of Indorsers

1. Warranties of Indorsers

a. An indorser who receives consideration for an instrument makes five warranties

as follows to subsequent transferees of the instrument:

(a) The indorser is entitled to enforce the instrument.

(b) All signatures are authentic and authorized.

(d) The instrument is not subject to a defense of any party which can be asserted

against the indorser.

(e) The indorser has no knowledge of the bankruptcy of the maker, acceptor, or

drawer.

2. Contract of Indorsers

a. Unless an indorsement states otherwise, every indorser agrees to pay any

subsequent holder the face amount of the instrument if it is dishonored.

b. To enforce this obligation, it is necessary for the holder to present the instrument

for payment to the maker or drawee when it is due and notify the indorser or

indorsers of any dishonor.

c. Time limits apply to the notice requirement and vary depending on whether the

holder is a bank or other holder.

E. Multiple Payees, Missing and Forged Indorsements (27-5)

1. If an instrument is payable to either of two payees, the indorsement of only one of the

payees is necessary for negotiation.

2. If an instrument is payable to both of two payees, the indorsement of both payees is

necessary for negotiation.

F. Unauthorized or Forged Indorsements

1. An unauthorized signature or indorsement is one made without actual, implied, or

apparent authority.

2. When an instrument is paid on a forged indorsement, the tort of conversion takes

place.

3. There are three exceptions to the general rule that an unauthorized indorsement has

no effect:

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Chapter 16 - The Nature of Negotiable Instruments

a. When an instrument is issued to an imposter on the false belief that the imposter

is the payee, the indorsement by any person in the name of the payee is treated as

an effective indorsement.

b. When an agent or employee of the maker or drawer pads the payroll by supplying

the employer with fictitious names, an indorsement by any person in the name of

any fictitious payee is effective.

c. When the maker or drawer of an instrument intends the payee to have no interest

in the instrument or the payee is a fictitious person, an indorsement by any person

in the name of the payee is effective.

V. Background Information

A. Cross-Cultural Notes

1. It is a serious matter in Dubai to write a bad check because jail time may be imposed.

For a discussion from the New York Times see

http://www.nytimes.com/2009/09/12/world/middleeast/12dubai.html?_r=0.

B. Historical Notes

1. As traders at commercial fairs of the Middle Ages bought items from one another, the

amounts due were recorded in the sellers’ books and were countersigned by the

purchasers. At the end of the fair, individuals settled debts. Balances were paid in

cash at first, but eventually it became customary for a debtor to sign a document

agreeing to pay the creditor at a certain date. These documents were the forerunners

of the modern bills of exchange.

2. The first demand notes were the first series of U.S. currency put into circulation. In

1861, at the start of the Civil War, an act of Congress authorized the U.S. Treasury to

issue legal tender notes in denominations of $5, $10, and $20. They were called

demand notes because they carried the statement “The U.S. promises to pay the

bearer...on demand.” These demand notes were also known as “greenbacks” because

they were green on one side.

3. Over the years, checks have served surprising purposes. For example, in 1867, the

United States paid for the territory of Alaska with a check for $7.2 million.

4. As long ago as the thirteenth century, it was common practice for bankers and

merchants to use bills of exchange as a means of transferring funds and making

payments without having to move gold or silver.

5. Traveler’s checks were first introduced in 1891 by American Express. Once

frequently used by travelers, fewer and fewer places accept them today. They may

still be an attractive alternative if travelling to an area that has few ATMs. They are

also an idea for emergency back-up.

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Chapter 16 - The Nature of Negotiable Instruments

6. Today, rubber and mechanical stamps, such as signature stamps and “for deposit

only” stamps, are vital to most business operations. However, prior to 1860, such

stamps were rarely used. The union used revenue stamps to help finance the Civil

War.

7. Before alternative systems of identifying customers were introduced, clerks at

Heywoods Bank in London wrote short descriptions of customers next to their sample

signatures. One description given is “short man; whiskers all round his face; one tooth

out in front. Looks like a coal heaver.” Additional information can be found at

http://www.martinsbank.co.uk/.

C. State Variations

1. A New York law states that it is illegal to arrest a dead man for debts.

2. Some states allow employers to require employees to accept direct deposit of payroll

checks whereas some states do not.

D. Quotations

1. A negotiable bill or note is a courier without luggage.

— John B. Gibson (1780–1853), American judge

VI. Terms

1. The word draft comes from the Middle English draught, which is akin to the Old

English dragan, meaning “to draw” or “to drag,” and the Latin trahere, “to pull” or

“to draw.”

2. The term bill is derived from the Latin billa, meaning “seal.” During the Middle

Ages, bill came to refer to any commercial document.

3. Forgery consists of making a false written instrument with the intent to defraud,

altering a genuine instrument in any way, or uttering a forged instrument. In this

sense, the word utter means “to offer” or “to pass for value in return.”

4. The word negotiable comes from the Latin verb negotiare, meaning “to carry on

business.” It is also derived from negotium, which means business and is a

combination of neg, meaning not, and otium, meaning leisure.

5. Indorse is an alternate spelling of endorse. Both terms developed from an Old French

word combining en, meaning on, and dos derived from the Latin dor-sum, which

means back. Thus, endorse means “to put on the back.” Today, under the UCC, an

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Chapter 16 - The Nature of Negotiable Instruments

indorsement may be on either side of the instrument, although it is usually placed on

the back.

6. The phrase “foot the bill” comes from the practice of signing one’s name at the

bottom of a bill to indicate acceptance of payment. However, the current popular

usage of the phrase indicates an acceptance to pay, making it similar to an

indorsement.

7. If a person is required by law to pay on a negotiable instrument, he or she may be said

to have to “shell out.” This colloquialism dates to colonial America when money was

scarce, and people often paid debts in shelled corn.

VII. Related Cases

1. Duncan Savings & Loan Association issued a money order for $24,190 payable to

McAffrey Funeral Home. When the instrument was presented for payment, Duncan

Savings and Loan refused payment because McAffrey had put a stop payment on the

money order. The court ruled that a drawer bank (Duncan Savings & Loan) on a

personal money order is liable notwithstanding a stop payment order unless able to

prove a valid defense. The S&L could not assert a defense, so it was required to pay

on the order. First National Bank of Nocona v. Duncan Savings & Loan Association,

656 F.Supp. 358 (W.D. Okla. 1987).

2. Intending to make a loan, X gave Y a check for $20,000, but neglected to sign the

check. The following day Y deposited the check to his account and delivered to X a

note promising to pay back the $20,000. A year later after Y defaulted, X sued the

bank for cashing his check without his signature. The court ruled against X

recognizing that the bank was relieved from liability, since X, accepted the note and

received payment on it constituting a ratification of the bank’s payment of the

unsigned check. Spec-Cast, Inc. v. First National Bank and Trust Co. of Rockford,

538 N.E.2d 543 (Ill. 1989).

3. A husband signed his wife’s name to a promissory note without her knowledge or

permission. In a bankruptcy proceeding, the court recognized that the wife was not

liable for the note because an unauthorized signature is wholly inoperative as that of

the person whose name is signed, unless that person later ratifies it. The wife neither

signed nor ratified the note. The court ruled, however, that she continued to be liable

on a preexisting note that was cancelled in reliance on the new note containing the

signature of the husband and the forged signature of the wife. In re Grove, 73 B.R.

(D. Minn. 1987).

4. The Alabama Supreme Court in Foster v. Hacienda Nirvana, Inc. applied the UCC’s

six-year statute of limitations for negotiable instruments to bar a claim for $200,000

based on the sale of horses. The plaintiffs’ unsuccessfully argued that a 10-year

statute of limitations applied if the promissory note was a contract under seal and also

that a contract under seal could not be a negotiable instrument.

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Chapter 16 - The Nature of Negotiable Instruments

VIII. Teaching Tips and Additional Resources

1. At https://www.fdic.gov/consumers/consumer/information/fdiciorn.html, the FDIC

provides an article titled “Insured or Not Insured?” noting that certificates of deposit

are a type of insured account.

2. The Federal Trade Commission provides information on fake check scams at

http://www.consumer.ftc.gov/articles/0159-fake-checks.

3. Additional information regarding check fraud, including videos, can be found at

http://fakechecks.org/prevention.html.

4. Information on the Federal Reserve’s automatic clearinghouse system is available at

http://www.federalreserve.gov/paymentsystems/fedach_about.htm.

5. At http://www.ct.gov/dob/cwp/view.asp?a=2235&q=297926 on the Internet site of the

State of Connecticut Department of Banking is an article referencing fraud involving

cashier’s checks.

6. Tips on using traveler’s checks can be found at

http://www.wlbt.com/story/684346/travelers-checks?redirected=true.

7. An article discussing traveler’s checks and other ways to obtain money while

traveling titled “Money Matters on the Road” can be found at

http://www.msnbc.msn.com/id/17009526/page/3/.

8. The Federal Deposit Insurance Corporation has a number of articles of interest to

consumers at http://www.fdic.gov/consumers/consumer/index.html.

9. A list of embezzlement warning signs is available on the web site of Findlaw.com at

http://smallbusiness.findlaw.com/business-finances/embezzlement-warning-signs.htm

10. Information from the Federal Bureau of Investigation on financial institution fraud is

available at

https://www.fbi.gov/about-us/investigate/white_collar/financial-institution-fraud

11. Information on identity theft is available at the web site of the American Association

of Certified Public Accountants at

http://www.aicpa.org/interestareas/informationtechnology/resources/privacy/pages/id

entitytheft.aspx.

12. Discuss with students alternatives to checks. An article titled “Latest Scam

Highlights Risks for Debit-Card Users” is available at

http://www.smartmoney.com/borrow/credit-cards/latest-scam-highlights-debitcard-da

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Chapter 16 - The Nature of Negotiable Instruments

ngers-1305329229415/. Another article from U.S. News Money titled “The Debit

Card Danger You’re Probably Forgetting” is available at

http://money.usnews.com/money/blogs/my-money/2014/09/22/the-debit-card-danger-

youre-probably-forgetting.

13. Ask students if they or their families have ever been the victims of check fraud.

Discuss steps to avoid such fraud with personal accounts and business accounts.

14. To introduce Negotiable Instruments, ask students to discuss how they manage and

use money. Have them explain how and why they conduct particular transactions

such as borrowing money and writing and cashing checks, and using debit cards.

Discuss various problems that arise when people exchange money, and ask students

to predict how such problems are addressed by the law.

15. Students may not realize that the rates of exchange among the different currencies of

the world not only vary slightly from day to day but also according to whether a

person is buying or selling the currency. Have students bring in currency exchange

rates for a full week. These may be obtained from a bank or a national newspaper.

Use these rates to show how the rates change daily. Ask students to relate examples of

monetary exchange problems encountered while traveling in a foreign country.

16. Remind students that if an instrument is indorsed in blank and is subsequently lost, it

can be cashed by anyone. If the instrument is a check, a bank will upon request, put a

“stop payment” order on the check so that an unintended holder of the instrument

cannot cash it.

17. Tell the class that “Pay to the order of” and “Pay to bearer” are the passwords of

negotiability. Without them, most instruments are not negotiable.

18. As you explain each type of indorsement, write it on the board or screen for students

to see. Emphasize the risks of a blank indorsement and the protection of special and

restrictive indorsements.

19. Emphasize that whenever anyone indorses an instrument, unless it is qualified, he or

she agrees to pay the face amount to any subsequent holder if the instrument is

dishonored and the proper notice is given.

20. Have students talk with a local bank official, police officer, and prosecuting attorney

to see what happens when a check is dishonored. What criminal ramifications are

possible? What steps will a police officer or prosecutor take before filing criminal

charges? What civil ramifications are possible? Discuss problems with proving

criminal intent in regard to post-dated checks. Results vary by state.

21. The maker or drawer of an instrument does not have to meet the impostor to be held

liable for any payments made. Fraud perpetrated through the mail is no exception to

the rule.

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Business Law with UCC Applications 14th Edition