Consigned to Confusion Consignments Under Revised Article 9

Consigned to Confusion Consignments Under Revised Article 9

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Editor's Note: This is the final column in a series of 20 Journal columns, written by Prof. Warner, that explore the changes in secured transactions law and bankruptcy law that may result from the revision of Article 9 of the UCC. Beginning in 2002, the Lien on Me column will no longer be limited to issues involving the Article 9 revision, but will include the whole range of secured transaction issues and will feature a number of different authors, many from ABI's UCC Committee. ABI members wishing to contribute future Lien on Me articles should contact [email protected].

The Article 9 revision radically changes the way the Uniform Commercial Code addresses consignments by moving the treatment of most such transactions from Article 2 into Article 9. While this change will greatly alter the legal analysis of consignment questions, the revision will have little practical effect in most cases. The primary effect of the revision is to bring most consignments into Article 9 and to treat them like purchase-money security interests in inventory. This is similar to the treatment of consignments under prior law.

While the revision clarifies a number of minor points that arose under prior law, it also creates some new areas of uncertainty. Part of that uncertainty arises from the subtle nature of the drafting choices. One must read the statute very carefully in order to work out the rules, and this author believes that both courts and practitioners may have difficulty reaching correct conclusions.

Consignments and Security Interests

A classic consignment is a transaction where the owner of goods delivers possession to a bailee who is also given the power to sell the goods to its customers. Title remains with the consignor until the goods are sold to the ultimate buyer and the consignee is free to return any unsold goods to the consignor. Under prior law, a purported "consignment" transaction might actually be a disguised "security interest." For example, if the purported consignee was not free to return unsold items but was required to purchase them, the transaction would be recharacterized as a secured sale—with the purported title that was retained by the consignor being limited in effect to a security interest. This recharacterization subjected the transaction to all of the usual Article 9 rules.

While the changes made by the revision reduce the importance of the consignment/security interest distinction, it is still the first step in the analysis. Under revised Article 9, all such "security consignments" are covered by Article 9 and treated as ordinary security interests.2 While this means that the purported consignor must perfect its interest in order to establish priority, the primary significance of the recharacterization is that the purported consignor cannot merely recover the consigned goods upon the consignee's default. Instead, the purported consignor must comply with the Article 9 repossession and sale rules. Thus, unless the purported consignee consents to a strict foreclosure, the purported consignor must conduct a UCC sale of the goods and account to the consignee if the sale produces a surplus.

True Consignments and "Sale or Return" Transactions

In addition, a distinction must be made between a "true-consignment" and a "sale-or-return" transaction. The two types of transactions are very similar in that in both cases the buyer/consignee is free to return the goods even though they conform to the contract. In a true consignment, the consignor transfers possession to the consignee, but retains title. However, in a sale-or-return transaction, title is transferred to the buyer upon delivery, but the buyer has a contractual right to return the goods.3 The conceptual distinction between the two is that a sale-or-return transaction is a present sale and the recipient of the goods is a "buyer," whereas there is neither a present sale nor a buyer in a true consignment. It is this technical conceptual distinction that caused the drafters to decide that consignments should be removed from Article 2—because Article 2 should deal only with the "sale" of goods.

Under the former law, both sale-or-return transactions and most true consignments were dealt with under §2-326 of Article 2 of the UCC. Under that section, goods held on sale-or-return were subject to the claims of the buyer's creditors while in the buyer's possession.4 Although true consignments were not technically sale-or-return transactions, former §2-326(3) provided that goods on consignment generally were deemed to be on sale-or-return if they were delivered for sale to a person who maintained a place of business at which he dealt with goods of that kind under a name different from the name of the consignor. The effect of this provision was to subordinate the title interest of the true consignor to inventory secured lenders, trustees in bankruptcy, lien creditors and even the general creditors of the consignee.

There were three ways in which the true consignor could avoid the effect of that section and preserve its priority with respect to the consigned goods. First, the section did not apply if the cosignor complied with an applicable sign law—although there apparently were no such laws. Second, the section did not apply if the consignee was "generally known by his creditors to be substantially engaged in selling the goods of others." However, this test was imprecise and was very hard to meet in most cases. The final method by which a consignor could protect its interest was by complying with the filing provisions of Article 9.

Former Article 9 accommodated §2-326 by permitting consignors to file protective "consignment" financing statements under former §9-408 and by subjecting them to priority rules almost identical to the rules that applied to purchase-money security interests in inventory.5 Since the only safe practice for consignors of inventory was to comply with the Article 9 filing requirements, this brought most consignments into former Article 9's filing and priority provisions as a practical matter.

Article 9 Applies to Most True Consignments

The revision amends former §2-326 to delete all references to consignments.6 Thus, consignments are no longer subject to Article 2, and its rule that goods on sale-or-return are subject to the claims of creditors no longer applies to them.7 Instead, the scope of Article 9 has been expanded to apply to "consignments,"8 a term that is broadly defined to cover a transaction, "regardless of its form," in which goods are delivered to a merchant for the purpose of sale.9

Despite the breadth of the general "consignment" definition, Article 9 expressly excludes from that definition five different classes of transactions that might otherwise be covered.10 First, consignments are excluded from the Article 9 definition if the merchant (1) conducts its business under the same name as the consignor, (2) is an auctioneer, or (3) is "generally known by its creditors to be substantially engaged in selling the goods of others."11 These exclusions largely carry forward the limitations that were either explicit or implicit in former §2-326(3). In addition, the Article 9 definition also excludes consignments where the goods were consumer goods immediately before delivery.12 This provision will exclude the situation where a consumer consigns used items to a resale shop. Finally, the revision excludes low value consignments where, "with respect to each delivery, the aggregate value of the goods" is less than $1,000 at the time of delivery.13

These "orphan consignments" are not covered by either revised Article 9 or revised §2-326. Ironically, although the general thrust of the Article 9 revision has been to provide explicit statutory answers to most questions, it takes the opposite approach with respect to "orphan consignments"—leaving their treatment to non-Code common law. Presumably, the non-Code law gives priority to the title retained by the true consignor;14 however, the consignor might have preferred the certainty provided by an express Code answer.

This issue may be important in some businesses such as the jewelry business, where consignments are common. If the jeweler is "generally known by its creditors to be substantially engaged in selling the goods of others," then Article 9 does not apply and the consignor's rights against competing creditors turn on non-Code law. Further, the consignor gains no rights by filing a financing statement or otherwise complying with the Article 9 rules. If, on the other hand, the jeweler does not meet the "generally known" test, then the consignor's priority depends on its compliance with Article 9. The "generally known" test is vague and does not yield predictable results. For example, although sophisticated lenders and other jewelers may know that a jeweler is substantially engaged in selling the goods of others, that may not satisfy the "generally known" standard if the landlord, phone company, electric company and other creditors do not have that knowledge.

Priority of True Consignments

Having pulled most true consignments into Article 9, the revision then defines the consignor's title interest to be a purchase-money security interest15 in inventory.16 This characterization of the consignor's interest has several effects. First, as a general rule, the consignor's title interest is subject to the claims of the creditors of, and purchasers for, value from the consignee. The revision accomplishes this result by deeming the consignee "to have rights and title to the goods identical to those that the consignor had or had power to transfer."17

However, since the revision defines the consignor's title interest to be a purchase-money security interest in inventory, the usual Article 9 priority rules apply, and no special consignment priority rules are required.18 Thus, like any holder of a "security interest," the consignor can obtain priority over most competing claimants by complying with the Article 9 perfection requirements.

For example, the consignor can obtain priority over trustees in bankruptcy and lien creditors,19 and over non-ordinary course buyers and lessees20 simply by filing a financing statement. However, since the consignor's interest is treated as a security interest in inventory, it will be subordinate to the rights of an ordinary course buyer or lessee even if it files a financing statement.21

Similarly, by filing or otherwise perfecting its interest, the consignor can obtain priority over any later-perfected security interest in the consigned inventory.22 In addition, like any other purchase-money security interest in inventory, the consignor can obtain priority over even an earlier-perfected inventory security interest if it satisfies the purchase-money priority rules. Those rules require that the consignor, before delivering the consigned goods to the consignee, must file its financing statement and send an authenticated notification to the holders of conflicting perfected inventory security interests advising them that it has or expects to acquire a purchase-money security interest in the described inventory of the consignee.23

Note that the new Article 9 filing rules may make it both easier and harder to comply with the filing and notice requirements. Since the inventory filings must now be made in the state of the debtor's location rather than the location of the goods, a single financing statement filed in a single state will perfect consigned goods located at stores throughout the nation.24 However, since virtually all filings relating to the debtor will be concentrated in a single filing office, and since super-generic "all-assets" descriptions are now permitted, a search for inventory-related filings may produce a large number of creditors who must be notified, even though many may in fact claim no interest in the particular consigned inventory.25

Enforcement of True Consignments

Although Article 9 defines true consignments as purchase-money security interests, it does not subject them to the Article 9 repossession and sale rules. While a "security consignment" would be subject to the usual Article 9 enforcement provisions, §9-601(g) provides that those provisions impose "no duties upon a secured party that is a consignor." As a result, a true consignor is free to enforce its title interest under applicable non-Code consignment law, without regard to the duties normally imposed on Article 9 secured parties.


1 The views expressed herein are Prof. Warner's and do not necessarily reflect the views of the University of Missouri or the law firm of Greenberg Traurig P.C. Special thanks to Prof. William Henning and the participants of the UCC Law listserve for explaining (and disagreeing about) the effects of the revision. The listserve commentators whose discussion piqued my interest in consignments and helped form my conclusions include Prof. Steven Harris, Randy Perlmutter, Prof. Allan Axelrod, Don Rapson, Prof. Paul Shupack and Prof. William Vukowich. Return to article

2 See §9-109(a)(1), cmt. 6 (covering a transaction, "regardless of form," that has the effect of creating a security interest); §9-102, cmt. 14; see, also, §1-201(37) (defining "security interest"); compare §9-102(a)(20)(D) (addressing consignments that create security interests). All citations are to the revised 1999 version of Article 9 of the Uniform Commercial Code (and the related conforming amendments to Articles 1 and 2) unless otherwise indicated. Citations to the prior version of Article 9 are indicated by the term "former." Return to article

3 This type of transaction is a sale-or-return transaction if the goods are delivered to the buyer primarily for resale. §2-236(1)(b). If the goods are delivered to the buyer primarily for use by the buyer, but the buyer has the right to return them, the transaction is a "sale on approval." §2-236(1)(a). An example of a "sale on approval" would be a 30-day no risk trial. Return to article

4 See former §2-326(2). This provision is retained by the revision. Return to article

5 Compare former §9-114 (consignments) with former §9-312(3) (purchase-money security interests in inventory). Return to article

6 See §2-326. Return to article

7 This change may cause confusion for two reasons. First, many attorneys are used to thinking of consignments as sale-or-return transactions. Second, the correct reading of revised §2-326 requires that great emphasis be placed on its use of the term "buyer," and a casual reader may not realize that the term excludes a consignee. Return to article

8 See §9-109(a)(4). Return to article

9 See §9-102(a)(20). Since this definition makes no reference to title retention, it appears to be broad enough to include a sale-or-return transaction. However, comment 6 to §9-109 states, without explanation, that a sale-or-return transaction is not included in the consignment definition. See §9-109, cmt. 6. Return to article

10 Of course, if the purported consignment is a disguised security interest, Article 9 will cover it even if it falls into one of these categories. See §9-102(a)(20)(D). Return to article

11 §9-102(a)(20)(A). Return to article

12 §9-102(a)(20)(C). Return to article

13 §9-102(a)(20)(B). This exception could surprise a perfected inventory secured lender since the aggregate effect of numerous small deliveries could be substantial. However, the value limitation may be too low to protect artists who place their works in galleries on consignment. Nonetheless, several states have non-UCC laws that override the UCC and protect consigned artistic works. See, e.g., N.Y. Arts & Cult. Aff. Law §1201 (McKinney 2001). Return to article

14 See §9-109, cmt. 6. Arguably, the §2-403(1) "derivative title" rule may yield that result; however, its application is uncertain because Article 2 no longer applies to true consignments. Note that the derivative title concept would give an "orphan consignment" priority over a perfected inventory security interest, even though the consignor did not file a financing statement or give notice to the prior perfected inventory lender. Return to article

15 Revised §1-201(37) defines the term "security interest" to include "any interest of a consignor...that is subject to Article 9." Return to article

16 Section 9-103(d) provides, "The security interest of a consignor in goods that are the subject of a consignment is a purchase-money security interest in inventory." Return to article

17 See §9-319(a). Return to article

18 See §9-319, cmt. 2. Note that §9-319(b) appears to defer to non-Code law to determine the rights of the consignor in those cases where it has priority over the competing creditor. The comments to §9-319 make clear that subsection (a) deals with the situation where the consignment is unperfected, and subsection (b) deals with the situation where the consignment is perfected and has priority over the competing creditor. Unfortunately, the statutory language is not so clear. Subsection 9-319(b) uses the terminology "if...a perfected security interest held by the consignor would have priority." This suggests a "hypothetical" test, rather than the "actual" test reflected in the comments, and may give rise to confusion. Return to article

19 See §9-317(a)(2). As the holder of a "purchase-money security interest," the consignor also gets the benefit of the 20-day grace period following delivery within which to file its financing statement. See §9-317(e). Return to article

20 See §9-315(a)(1) and §9-317(b) and (c). Note that, unlike prior law, the 20-day grace period now applies to all non-ordinary course buyers and lessees, and not just to buyers in bulk. See §9-317(e) and cmt. 8. Return to article

21 See §9-320(a) (ordinary course buyer) and §9-321(c) (ordinary course lessee). Return to article

22 See §9-322(a)(1) ("first to file or perfect" priority rule). Return to article

23 See §9-324(b). The holders of the conflicting interests must receive the notice within five years before the consignee receives possession of the goods. Return to article

24 See, generally, Warner, G. Ray, "Secured Transactions: New Filing Rules Follow the Debtor," 19 Am. Bankr. Inst. J. 16 (March 2000). Return to article

25 See, generally, Warner, G. Ray, "Secured Transactions: Documenting a Transaction Under Revised Article 9," 19 Am. Bankr. Inst. J. 20 (April 2000). Return to article

Journal Date: 
Saturday, December 1, 2001