Navigating the Consignment Rules under UCC Article 9
UCC §9-102(a)(20) defines consignment as "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."
Generally, if the consignee under such a consignment arrangement files for bankruptcy relief, the consigned goods are property of the consignee's bankruptcy estate. Accordingly, 11 U.S.C. §362(a)(3) prohibits the consignor from picking up the consigned goods after the filing of the bankruptcy. Additionally, if the consignor picks up the goods, (1) the consignor may be subject to a turnover action under 11 U.S.C §§542 or 543 for their return and/or (2) within 90 days prior to the bankruptcy filing, the consignor may be subject to a preference action under 11 U.S.C. §547(b) for their return.
The typical consignor is relegated to the status of a general unsecured creditor. However, the consignor has the prospect of improving that status. UCC §9-103(d) provides that a consignor of goods holds a purchase-money security interest in the consigned goods as inventory. That purchase-money security interest is useless and inferior to the claims of the debtor's other inventory secured parties, however, unless certain additional actions are taken.
First of all, the consignor must perfect its security interest. If a potentially competing secured party in the debtor's inventory has already filed a financing statement with respect to the debtor's inventory, it will also be necessary to provide a separate notice to such competing secured party before the consigned goods are delivered. The reasoning behind these rules is simple: notice to the world of the consignor's superior claim to and interest in the consigned inventory. A creditor seeking to lend money to the debtor may base the loan in part on the value of the debtor's inventory and should not bear the risk that the inventory is actually consigned goods. Since the bankruptcy trustee steps into the role of a hypothetical lien creditor, the trustee's rights are superior to the rights of the consignor unless the consignor has at least taken the perfection step prior to the bankruptcy filing.
As previously mentioned, the consignor may proactively protect its rights in the consigned goods by perfecting its purchase-money security interest in the consigned goods that UCC §9-103(d) creates. To perfect its security interest, the consignor must file an appropriate UCC financing statement. In addition, in order to attain priority over the interest of an inventory secured party of the debtor who has previously filed a UCC financing statement against the debtor's inventory, the consignor must take the extra step of providing specific notification of the consignor's intended purchase-money security interest to the competing inventory secured party. Both the filing of the UCC financing statement and the sending and receiving of the specific notification, where applicable, must take place before the consigned goods are delivered. The consignor must also take care to maintain its first-priority perfected security interest by filing periodic continuation statements as required under UCC §9-515 and by sending new notices of the purchase-money security interest to the other inventory secured parties every five years. Assuming the consignor complies with the foregoing perfection requirements for a purchase-money security interest (contained in UCC §9-324(b)) and thereafter maintains such perfection, the consignor will enjoy rights in the consigned goods superior to those of the bankruptcy trustee. By perfecting its security interest in the consigned goods, the consignor's status is elevated from that of a general unsecured creditor to that of a secured creditor in the debtor's bankruptcy.
A special rule is set forth in UCC §9-319 regarding the rights and title of a consignee in consigned goods. Even though a consignee is essentially nothing more than a bailee and has only very limited rights in the consigned goods, this section provides that insofar as creditors of the consignee and purchasers for value of the consigned goods are concerned, the consignee is deemed to have rights and title to the goods identical to those that the consignor had or had the power to transfer, if the consignor's interest is unperfected. By contrast, if the consignor has taken the necessary steps to achieve a purchase-money security interest priority vis-à-vis a particular creditor of the consignee, then any security interest or lien claimed by that creditor will and can attach to only the very limited interest in the consigned goods that the consignee actually has.
There are numerous requirements and exceptions to the foregoing rules. Many transactions that have often been referred to as "consignments" are not deemed to be consignments for the purposes of the foregoing rules. For example, transactions involving goods "consigned" to auctioneers, goods delivered "on consignment" to what generally everyone knows is a consignment shop, goods "consigned" to a merchant for resale, for any delivery where the aggregate value of the goods is less than $1,000, and goods that were consumer goods (i.e., goods used or bought primarily for use for personal, family or household purposes) in the hands of the "consignor" are definitely not consignments. These transactions are, or may be, "true consignments" (in the usual sense), but the drafters of UCC Article 9 consciously chose not to have Article 9 apply to them. Moreover, if the goods will not be delivered, at least in part, to a merchant for resale, there can be no consignment under Article 9. Similarly excluded are transactions that may be designated as "consignments" but that, in reality, are transactions that secure an obligation (other than the "consignee's" obligation to return the "consigned" goods). When in doubt about whether the Article 9 consignment rules apply, the "consignor" should take all steps necessary both to create and perfect a purchase-money security interest in the "consigned goods."
These transactions are, of course, "regular" security interests under Article 9 and must be handled accordingly (perfection, notification to competing secured parties, etc.). Also excluded are "sale or return" transactions that are often incorrectly categorized as "consignments." In a "sale or return" transaction, the buyer becomes the owner of the goods (albeit with a right to return them to the seller if they are not sold), and the only practical way the seller has to protect its rights in the goods is through the traditional method: entering into a security agreement with the "consignee," perfecting the security interest and providing appropriate advance notice to competing secured parties. When in doubt about whether the Article 9 consignment rules apply, the "consignor" should take all steps necessary both to create and perfect a purchase-money security interest in the "consigned goods." In this regard, Article 9 expressly recognizes "just in case" filings in §9-505.
In summary, consignors should be aware that consigned goods held by a debtor for resale are generally property of the debtor's bankruptcy estate and they will be subject to the potentially superior claims of the debtor's bankruptcy trustee and/or the debtor's inventory secured parties. Absent perfection of its purchase-money security interest in the consigned goods and, in appropriate cases, the sending of notices to the consignee's other inventory secured parties, the consignor can expect to be relegated to the position of a general unsecured creditor.
1 Edward A. Keirn, special counsel for Commercial Transactions and Consumer Financial Services at Barnes & Thornburg, contributed to this article. This article should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.