Retail Bankruptcies and Their Impact on Consigned Goods
The next time you take a trip to your favorite retailer, stop for a moment and think about the various goods for sale. Did the retailer order and pay up front for 100 pairs of tennis shoes, hoping it will sell every pair to recoup their costs + profit?
In most retail situations, the retailer obtains goods from various suppliers and the suppliers provide those goods on a consignment basis. Essentially, the supplier provides the goods to the retailer and the supplier maintains title to the goods until the retailer sells the goods. Once the retailer sells the goods, the supplier invoices the retailer for the cost of the goods sold. If the retailer doesn’t sell the goods, the retailer can simply return the goods to the supplier.
Although it’s not widely practiced, a supplier can and should ensure it takes appropriate action to perfect its security interest if supplying goods on consignment.
Article 9 & Consignment
Consignments hover somewhere between Articles 2 & 9 of the Uniform Commercial Code. We focus on what falls under Article 9. How do you know if the consignment falls under Article 9?
“UCC Section 9-102(a) (20), states the following:
Consignment means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and:
(A) the merchant:
(i) deals in goods of that kind under a name other than the name of the person making delivery;
(ii) is not an auctioneer; and
(iii) is not generally known by its creditors to be substantially engaged in selling the goods of others;
(B) with respect to each delivery, the aggregate value of the goods is $1,000 or more at the time of delivery;
(C) the goods are not consumer goods immediately before delivery; and
(D) the transaction does not create a security interest that secures an obligation.”
Edwin E. Smith provides a great example in his article Understanding Consignments in Retail Bankruptcies.
“There are a number of consignment transactions that fall outside of the UCC definition. For example, I might take my bicycle to the consignment shop for sale by the shop. Since the bicycle is a consumer good in my hands before delivery, the consignment falls outside of the UCC definition. Or I may take my office desk chair used in my business to the consignment shop for sale. The office chair is not a consumer good in my hands since I use it in my business. However, if the chair’s value is less than $1,000, the consignment would fall outside of the UCC definition. The shop may use the term “consignment” in its name and may advertise on its website that it deals with consigned goods. In that case, a consignment to the shop may fall outside of the UCC definition since the consignee may be ‘generally known by its creditors to be substantially engaged in selling the goods of others.’”
Why File a UCC? One Word: Bankruptcy
When you sell on consignment and fail to perfect a security interest, you will join the pool of unsecured creditors if your customer files for bankruptcy protection.
“If the consignor does not file the financing statement, the consignee’s interest in the consigned goods is subordinate to a lien obtained by a creditor of the consignee using the judicial process. Article 9 refers to that creditor as a “lien creditor.” If the consignee became a debtor in a bankruptcy case, the consignee’s bankruptcy trustee under Section 544(a) of the Bankruptcy Code has the status of a hypothetical lien creditor. The trustee may use that status to set aside an unperfected consignment interest and treat the consignor’s claim to the goods as a general unsecured claim.”
Unsecured creditors may think they have a ‘fallback plan’ of reclamation or administrative claims under section 503(b)(9) of the bankruptcy code. But Smith reinforces that reclamation rights and administrative claims are only available to those who sold to the debtor. Technically, consignment is not a sale.
What can a creditor do if no security interest exists? Here are parting words from Smith:
“The consignor can take the position that the consignment falls outside of the UCC definition of the term “consignment,” usually because the consignee is “generally known by its creditors to be substantially engaged in selling the goods of others.” If the consignor is successful in that argument, the consignor, as owner of the goods, will, as mentioned above, prevail as to the goods over the claims and interests of creditors and the bankruptcy trustee of the consignee. However, that position depends on facts that may or may not favor the consignor and will lead to expensive and time-consuming litigation. A consignor’s understanding of the commercial law rules applicable to consignments, including those of the UCC, and careful planning by the consignor should avoid these types of disputes.”
Or – don’t risk it.
Always perfect a security interest. Always!