Jewelry Retailer Debtor May Not Include Consignment Goods as Part of Section 363 Sale

By: Jonathan Borst

St. John's Law Student

American Bankruptcy Institute Law Review Staff

 

In In re Whitehall Jewelers Holdings, Inc.,

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the court held against Whitehall Jewelers Holdings, Inc. (“Debtors”), in favor of approximately 124 consignment vendors (“Consignment Vendors”), where Debtors sought an order permitting the “free and clear” sale of all of their assets and inventory, including consigned goods from Consignment Vendors.

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Section 363(f)(4) of the Bankruptcy Code

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permits the sale of assets free and clear of the interests of non-debtors if those interests are subject to bona fide dispute.  In this case, the Debtors argued that the Consignment Vendors’ interests in consigned goods were in dispute due to the failure of many vendors to properly perfect their consignment interests under UCC Article 9 and UCC section 2-326, which makes goods sold in a “sale or return” transaction subject to creditor claims.

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  However, the court turned its attention to the largely “ignored or avoided threshold issue” of whether the consigned goods were even property of the Debtors’ estate under section 541.

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  The court held that Debtors utilized “the wrong procedural tool, i.e., a contested matter,”

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instead of the required adversarial proceeding under Federal Rule of Bankruptcy Procedure 7001(2), in order to “determine the validity, priority, or extent of [an] interest in property.”

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  Thus, Debtors did not meet the initial burden of establishing that the consigned goods were property of the estate, and could not proceed with the sale of the consigned goods.

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Debtors argued that as a result of the Vendor Trading Agreements (“VTA”) between the parties, which incorporated provisions of the UCC relating to consignment, the rights of the Consignment Vendors were subordinate to the rights of Debtors’ creditors.

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  Significantly, the applied “property of the estate” threshold test allowed the court to avoid ruling on the section 363(f)(4) bona fide dispute issue.  If the relevant UCC provisions had instead been applied,

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it seems likely that the consignment goods would be considered in bona fide dispute.  For example, UCC section 2-326 provides that goods held on sale or return “are subject to [the claims of the buyer’s creditors] while in the buyer’s possession.”  Since the consigned goods were in the buyer’s possession, and according to the VTA, the goods were “sold to Whitehall by Vendor on a ‘sale or return’ basis,”

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it seems reasonable for Debtors to believe that section 2-326 would subject the goods to the claims of the Debtors creditors, which would in turn make the goods in bona fide dispute.  Similarly, since UCC section 9-103(d) treats most consignments as purchase money security interests, the failure to perfect would allow those interest to be avoided under the section 544 “strong arm” power.

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Given the apparent validity of Debtors’ argument, the court’s decision may have been influenced by other case-specific factors, such as the significant amount of undetermined factual issues,

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and that an inclusion of consignment goods as part of the proposed 363 sale would be a final disposition of the property.  Nonetheless, the effect of the decision is significant since it effectively prevented a prompt free and clear sale.  As the court noted, the Debtors’ would have to file and resolve more than 120 adversary proceedings prior to conducting a sale.

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  The reasoning of the opinion is not limited to consignment cases, but extends to any situation where the debtor’s interest in the property is in dispute.  The potential impact of the case is made more extensive by the court’s rejection of the debtor’s argument that the broad section 541 definition of property of the estate meant that consigned and “sale or return” goods were property of the estate, even if the Debtors’ rights were less than full title.

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