In her Secured Transactions column, Barbara M. Goodstein discusses two recent decisions in the Sports Authority bankruptcy which underscore the continuing challenge to UCC commentators in guiding courts and practitioners effectively through the world of consignments.
In a typical consignment, a seller (the consignor) delivers goods to an intermediary or middleman (the consignee) which holds those goods for sale to a third party. The goods can be sold to the consignee, or they can be held by the consignee subject to sale (a bailment), in either case pursuant to an arrangement in which the consignee shares with the consignor, in whole or in part, the proceeds of the sale of those goods to the third party. Consignment sales can be a major part of a retailer's or distributor's business plan. However, goods in the possession of a bankrupt consignee can become property of its bankruptcy estate even if the property hasn't been sold to the consignee. Unfortunately, oftentimes this fact doesn't become apparent to creditors of a retailer or distributor until it files for bankruptcy protection.
The rules governing consignments can be somewhat baffling to lawyers, so much so that the UCC Permanent Editorial Board released its latest official commentary earlier this year (which includes amendments to the UCC Official Comments (PEB Commentary No. 20 Consignments (Jan. 24, 2019))) just on consignments. Two recent decisions in the Sports Authority bankruptcy, one issued prior to the recent PEB commentary but one after it as well, underscore the continuing challenge to UCC commentators in guiding courts and practitioners effectively through the world of consignments.
Law of Consignments
A consignment for UCC purposes is understood to be a bailment, meaning the consignor (i.e., bailor) remains the owner of the consigned goods while they are held for sale by the consignee (i.e., the bailee). As discussed in the January 2019 PEB Commentary, consignments can be governed either by UCC Article 9 or common law. Under common law, the consignee's rights in the consigned goods are limited and its creditors cannot assert claims against those goods. Under Article 9, on the other hand, creditors of the consignee can assert claims against the consigned goods, in certain circumstances with priority over the rights of the consignor (and its creditors), notwithstanding that the consignor has legal title and the consignee does not.
UCC §9-102(a)(20) contains the Article 9 definition of a "consignment." That section contains an interesting mix of requirements. In order to constitute a consignment under Article 9, a transaction (regardless of form) must involve delivery of non-consumer goods with an aggregate value of at least $1,000 to a "merchant" (defined in UCC §2-104 as someone who deals in or is otherwise knowledgeable about the goods) who is not an auctioneer, provided the merchant (1) deals in those kinds of goods under a name other than that of the consignee and (2) is not generally known by its creditors to be "substantially engaged" in selling the goods of others, and provided further that the transaction itself does not create a security interest. As noted above, Article 9 grants significant rights to creditors of and purchasers from a consignee in comparison to non-Article 9 consignee creditors. Under UCC §9-319(a), while goods are in the possession of a consignee, it is deemed to have rights and title to such goods identical to those of the consignor. Thus, a consignor may unexpectedly find itself at risk should its consignment fall within Article 9, and must protect its interest in its goods in a way that does not apply to a consignor in a common law consignment.
The interest of the consignor in the goods is a "security interest" under UCC §1-201(b)(35) (notwithstanding that the consignor has title). Accordingly, the consignor must file a UCC financing statement to protect that interest from claims of creditors of the debtor/consignee. Perfection of course doesn't mean priority, and a perfected interest may defeat a judicial lien creditor, including a trustee in bankruptcy, but not other prior perfected creditors of the consignee. However, Article 9 provides a countervailing benefit to a consignor. Under UCC §9-103(d) a consignor's interest is deemed a purchase-money security interest in inventory. That means if the Article 9 consignor follows the strict rules of UCC §9-324(b) applicable to purchase-money inventory security interests, it will have priority over prior perfected liens. That also means, however, that the consignor must not only file a UCC financing statement against the consignee covering the consigned goods, but must as well notify creditors of the consignee of its interest in order to protect those goods from the claims of creditors of the consignee.
The policy behind all of this is obvious. Public notice of a consignor interest is warranted if the reasonable assumption is that the merchant (consignee) is selling its own goods and not goods belonging to someone else.
But too few consignors seem to be aware of this issue. Compounding this problem is that courts have difficulty providing proper guidance for when a consignment falls within the boundaries of Article 9. Both of these issues are illustrated by the recent battles among creditors in the Sports Authority cases of TSA Stores, Inc. et al v. Performance Apparel Corp. a/k/a Hot Chilly's Inc. (In re TSAWD Holdings, Inc., 595 B.R. 676 (Bankr. D. Del. Nov. 26, 2018) (the PAC case) and TSA Stores, Inc. et al v. Sport Dimension Inc. a/k/a Body Glove (In re TSAWD Holdings, Inc.), 601 B.R. 599 (Bankr. D. Del. April 12, 2019) (the Sport Dimension Case) before Judge Mary F. Walrath.
Sports Authority Cases
Sports Authority Holdings Inc. and its affiliates were national retailers of sporting goods and active apparel that filed for bankruptcy in Delaware on March 2, 2016. The debtors were parties at the date of filing to a 2006 syndicated secured term loan facility with Bank of America as Administrative Agent which had approximately $276 million of outstanding debt as of the petition date. That debt was secured by financing statements filed in 2006 and amended shortly before the bankruptcy to reflect Wilmington Savings Fund Society (WSFS) as successor agent to Bank of America.
The debtors had in place a program for the sale of goods on consignment that paid vendors (consignors) either a fixed amount for each item sold or a percentage of the retail sale price. Performance Apparel Corp. (PAC) and Sport Dimension Inc. were among those vendors. PAC filed a UCC financing statement but it had expired without continuation as of the date of bankruptcy. Sport Dimension filed a UCC financing statement approximately one month prior to the bankruptcy filing. In both cases, WSFS and the vendor filed competing claims against each other relating to the consigned goods (and their proceeds).
As expected, in each proceeding WFSF asserted that the interest of the vendor (consignor) was an Article 9 consignment, and so was required to be perfected by a UCC financing statement filing. In the PAC case, WSFS asserted priority over the vendor interest based on PAC's failure to continue its financing statement. In the Sport Dimension case, WSFS argued that it had priority because its financing statements were filed before the Sport Dimension UCC filing.
In each case, the vendors responded by arguing that the consignment at issue did not fall within the UCC definition of a consignment under UCC 9-102 and so no financing statement filing was required. The dispute in both cases as to whether the consignments were subject to Article 9 focused entirely on the condition under UCC 9-102(a)(20) that the merchant not be "generally known by its creditors to be substantially engaged in selling the goods of others."
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