Consignments the UCC and the Bankruptcy Code Part One
A consignment contract has been defined as the consignment of goods to another for a sale, under the agreement that the consignee will pay the consignor for any goods sold and will return any unsold goods.1 UCC Article 2 has a special provision governing consignments.2 UCC §2-326(3) states:
Where goods are delivered to a person for sale, and such person maintains a place of business at which he deals in goods of the kind involved under a name other than the name of the person making delivery, then, with respect to claims of creditors of the person conducting the business, the goods are deemed to be on sale or return. The provisions of this subsection are applicable even though an agreement purports to reserve title to the person making delivery until payment or resale, or uses such words as "on consignment" or "on memorandum." However, this subsection is not applicable if the person making delivery (a) complies with an applicable law providing for a consignor's interest or the like to be evidenced by a sign, (b) establishes that the person conducting the business is generally known by his creditors to be substantially engaged in selling the goods of others, or (c) complies with the filing provisions of the Article on Secured Transactions (Article 9).3
The effect of §2-326(3) is to make goods delivered on consignment available to satisfy the claims of a debtor's creditors. However, §2-326(3) provides three methods by which a consignor can protect itself. First, if the jurisdiction has a sign law, the consignor can place a sign in the consignee's premises stating that its goods are there on consignment. The purpose of the sign is to place creditors on notice that the goods are not the debtor's property and the creditor should not rely on the presence of these goods when making its determination to extend credit to the debtor. The second method through which a consignor can protect itself is to establish that it is generally known by the debtor's creditors that the debtor deals in consigned goods. If the debtor's creditors know that it substantially deals in consigned goods, then they will not make imprudent credit decisions based upon the existence of the consigned goods. Finally, a consignor may file a financing statement. Filing a financing statement is the most prudent course of action because it places the world on notice that the debtor will be receiving consigned goods, and because filing a financing statement is inexpensive. Filing a financing statement will protect a consignor in a bankruptcy case against the claims of the general creditors.
One of the potential problems concerning a consignment arrangement is that the purported consignment arrangement might in actuality be a hidden security agreement.4 Whether an agreement is a consignment agreement or security agreement is dependent upon the intent of the parties at the time they entered into the transaction.5 The following factors generally reflect that a consignment is intended as a security device:
- The consignee determines the resale price.
- The proceeds of the sales of the consigned goods are commingled and the failure to maintain segregated accounts.
- Consigned goods are mixed with other goods owned by the consignee.
- The consignor is purporting to retain title until paid.6
The following factors reflect that a transaction is intended as a true consignment:
- The consignor determines the sale price of the consigned goods.
- The consignee only has authority to sell the consigned goods upon the express approval of the consignor.
- The consignor may recall the goods.
- The consignee is entitled to a commission from the sale of the consigned goods.
- The consigned goods were segregated from the consignee's other goods.
- The consignee has no obligation to pay until the goods sold are paid for.7
In re Sullivan8 is a bankruptcy case that involved a consignment arrangement. In Sullivan, the debtor and Prince Oil had entered into a Commission Marketing Agreement (Agreement). The court analyzed the Agreement, and it held that the transaction was a true consignment. The court stated:
In applying the Ide Jewelry factors to the present case, the court examined closely the Commission Marketing Agreement entered into between Prince Oil and the debtor and observed the following terms, which are all indicative that the transaction constituted a true consignment rather than a security agreement: (1) Prince Oil retained sole control over setting the retail price (paragraph #2); (2) the debtor received a commission rather than a profit (paragraph #6); (3) Prince Oil retained the right to inspect and/or audit all records of the debtor relating to gasoline sales (paragraph #17); all proceeds from the sales of gasoline were to be segregated and deposited daily to the account of Prince Oil in a bank depository designated by Prince Oil (paragraph #8); and the debtor became obligated to pay for gasoline when it was sold rather than it was delivered (paragraph #8).9 (Footnote omitted).
The court also held that Prince Oil had priority over the trustee in the consigned goods. Prince Oil had posted two conspicuous signs that would have placed a prudent creditor on notice that the property did not belong to the debtor. The court ruled that Prince Oil had complied with the Mississippi sign statute.
Sullivan reflects that even if a transaction is a true consignment, a consignor has to comply with §2-326. A consignor's failure to comply with §2-326 will render the consigned goods available for distribution to the consignee's unsecured creditors. Consequently, it is imperative that, at the bare minimum, a consignor file a financing statement so that it will be able to protect itself if the consignee files for bankruptcy.