Consignment UCC Filings and the Sports Authority Bankruptcy
A company selling on consignment takes an unnecessary risk when it forgoes filing a UCC-1 Financing Statement. Complying with Article 9-324 of the UCC can protect a creditor from its debtor’s existing creditors and its debtor’s future creditors, because the UCC creates a public record of the creditor’s security interest.
What is a Consignment Filing?
In a previous post we explained the basics of a consignment and you can read that post here (or view the infographic here). Essentially, when a consignment agreement and UCC are filed:
“The consignor/owner retains title to the delivered goods, while the consignee/recipient holds and attempts to sell the goods. If and when those goods are sold, the owner’s security attaches to the proceeds of the sale. If the consignee is unable to sell the goods, they can simply return the goods to the owner.”
Why Would I File a UCC if I’m Selling on Consignment?
Because the law allows you to secure your goods! A simple consignment agreement is often viewed by the courts as a “secret lien” and may not be enough to protect you if your debtor defaults or files for bankruptcy protection, as there is no legal/recorded document identifying your title to the goods provided to the debtor.
If the debtor files for bankruptcy protection, the inventory the debtor has on hand is gathered up and sold off to pay creditors (secured creditors first and then the unsecured creditors). Without the UCC filing identifying you as a secured creditor and specifically identifying your goods, the inventory you supplied automatically becomes property of the estate.
Consignment Sales & the Sports Authority Bankruptcy
This is an unfortunate, yet classic, case of “too big to fail”. Shortly after filing for bankruptcy protection, Sports Authority filed complaints against its creditors, stating these creditors sold on consignment without filing a UCC and are therefore unsecured. (The number of complaints filed by Sports Authority is over 150, some sources say as high as 165.)
The complaints filed by Sports Authority will be used to determine whether or not a creditor is secured and the priority of the creditor. If the judge determines these creditors are unsecured, the inventory in Sports Authority’s possession could be plopped into the pool of items to be sold and the proceeds of that sale will be distributed to secured creditors first.
According to L. John Bird of Fox Rothschild LLP
“If Judge Walrath agrees … consignment vendors will have only a security interest, governed by the Uniform Commercial Code as enacted in Delaware and the principles of bankruptcy law. Pursuant to the Post-Petition Financing order entered in these bankruptcies, the Debtors have given their DIP Lenders a first-lien security interest in all assets not otherwise encumbered by a perfected lien. This means that for any shipments that were not properly perfected (by filing a UCC-1 statement within 30 days of shipment), the consignment vendors may not have a 1st priority lien.”
Sports Authority is a large company with creditors like Nike & Under Armour. Creditors selling to these large companies often have a false sense of security… “Eh, I don’t have to file a UCC, Sports Authority is a large company, they will pay.”
Is a UCC Filing Required?
Short answer: No. Creditors are not required to file a UCC. In default or bankruptcy situations, when a creditor is selling on consignment, there is a slight chance the creditor could argue it’s common knowledge that the debtor engages in consignment sales.
But making that argument seems shaky at best, not to mention inefficient – how much time would it take to successfully make that argument vs. filing the UCC and granting a security interest at the beginning of the relationship?
Best Practice
If selling on consignment, execute a security agreement & ensure it includes clear identification of inventory, search for existing secured creditors & notify those creditors of your security interest, file the UCC-1 in the appropriate jurisdiction(s) – if possible, and file the UCC prior to the debtor taking possession of the inventory.
Don’t neglect a simple opportunity to be a secured creditor.
