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Consignment and Bankruptcy

Consignment arrangements are very common in certain industries that are active in New York City, such as for sale of jewelry, fine art and antiques. In a consignment transaction the consignor (owner) of the merchandise gives it on consignment to the consignee for resale. The consignee does not have to pay the consignor until the goods are actually sold and the consignee has received payment. Some common example of this are a wholesale jeweler who consign loose stones or jewelry to a retail jewelry store, an artist who consign a painting to an art gallery, or an antique furniture owner who consign it to an antique shop for resele.

1. What is a consignment?

Under a consignment arrangement the consignor retains title and ownership of the consigned goods until they are sold by consignee. Unlike a regular sale the consignee does not have an obligation to pay for the goods until they are actually sold. In addition, in a consignment arrangement if the goods do not sell the consignee can usually return them to the consignor. The goods received on consignment do not form part of the assets of the consignee – and remain property of the consignee.

As between the consignor of the goods and consignee a consignment memorandum or similar document is usually used to document the consignment. While this may be satisfactory evidence of the consignment in the event of disputes between the consignor and consignee, different rules apply when a other creditors, judgment enforcement or bankruptcy is involved.

2. Uniform Commercial Code Applies to Consignments

The Uniform Commercial Code (UCC) governs secured transactions involving businesses. Under the UCC a consignment memo or similar document is not enough to prove a consignment arrangement as against a secured creditor or bankruptcy trustee. So, for example, if a jewelry store in Manhattan files for bankruptcy and has consignment jewelry and loose stones in its possession, the trustee in the consignee/jewelry store bankruptcy case will be able to treat the consignee as a nonpriority unsecured creditor and treat the consigned jewelry as part of the debtor jewelry store’s property. Simply put, if you are the consignor in this situation you are at risk to not get your jewelry back. There are certain exceptions but they typically require expensive litigation and may difficult to prove (i.e., such as that consignee is generally know by its creditors to be dealing in the goods of others).

a) Need to File UCC-1 Financing Statement

In order to protect a true consignment from the claims of a judgment creditor levying on a judgment against the consignee or trustee in bankruptcy, a consignor may file a UCC-1 financing statement. This is a form that the consignor files in the State where the consignee is incorporated or organized.
A properly prepared financing statement filed in the correct location puts the world on notice of the consignment arrangement because “secret liens” are legally disfavored. It is a form that can be inexpensively obtained in bulk from any legal stationary store. Completing the form is fairly straightforward and requires accurately listing the consignee’s full legal name, address, the consignor’s name and address and an accurate and complete description of the consigned goods. Any company that is active in consignment transactions can establish a system with minimal attorney oversight to correctly prepare and file UCC-1 financing statements. It is important to note that the UCC-1 alone is not enough to create a consignment arrangement – it is just the public notice of the consignment. There still needs to be some underlying documentation regarding the consignment, such as a consignment memorandum or agreement.

b) Intercreditor Agreement With Consignee’s Secured Lenders

Oftentimes a consignee that receives goods on consignment, such as a retail jewelry store or art gallery, will have bank financing. The bank financing or factoring is often made in the form of the secured loans. As part of the loan agreement the borrower/consignee often will grant a “blanket security interest” over all its assets to the bank. To protect itself from having its consigned goods subject to the bank’s blanket security interest on all of the consignee’s assets, in addition to filing a UCC-1 financing statement the consignee will also need to enter into an intercreditor agreement with the consignee’s bank or other secured lenders. This is an agreement where the bank acknowledges that its security agreement does not extend to the consignor’s goods on consignment with the debtor or proceeds of sale of such goods.

Conclusion

Unfortunately many businessmen, even those who have been in business many years, have very little familiarity with the laws governing consignments. Those who fail to follow the simple steps described above — and feel that spending even relatively small amount of money on attorneys in relation to what is at stake is not a good use of company funds — often discover to their great shock and dismay in the event the consignee becomes subject to judgment enforcement by creditors, insolvent or files for bankruptcy that they will not be able to get their goods back. Had they followed the steps detailed above they would be protected. We have seen creditors literally loose hundreds of thousands of dollars where a little time and small investment in obtaining legal advice at the outset would have protected their true consignment status.

At Starr & Starr, PLLC we can assist consignors with establishing a UCC-1 preparation and filing system to properly protect their status as true consignment creditors. In addition, we assist consignors and consignees with bankruptcy and insolvency issues involving consignments. Please feel free to contact us at888-867-8165 to schedule a consultation.

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