The layman’s common conception of goods sold on consignment is that a supplier delivers goods to a retailer who does not pay for the goods until they are sold, and the supplier can get the unsold goods back on demand. However, when disputes arise between a so-called consignment supplier and other suppliers and lenders, the determination of priorities and rights to payment become more complex. When such disputes arise in a bankruptcy proceeding, determining those rights becomes more complex. Apparel is frequently sold on consignment, and the law that applies can be frequently misunderstood by the parties involved.
Such was the case in the Sports Authority bankruptcy reorganization proceedings under Chapter 11 of United States Bankruptcy Law. The case is TSAWD Holdings, Inc. (Sports Authority) before the United States Bankruptcy Court for the District of Delaware. Two general creditors and a secured lender were in a dispute as to which party had priority in certain inventory and its proceeds. One supplier, Soffe, sold goods to Sports Authority on consignment.
The discussion now becomes technical as to what provision of commercial law applies. Section 9-102(a)(20) of the Uniform Commercial Code (“UCC”) defines “consignment” as a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale, and the merchant deals in goods of that kind under a name other than the name of the person making the delivery. The merchant is not an auctioneer and is generally known by its creditors to be substantially engaged in selling the goods of others. With respect to each delivery, the aggregate value of the goods is $1,000 or more at the time of the delivery, the goods are not consumer goods immediately before delivery and the transaction does not create a security interest that secures an obligation.
The dispute centered around the claims of Soffe, other general creditors and a secured financial lender. The issue was centered on when Soffe filed a UCC-1 financing statement, that date’s relationship to when the Sports Authority bankruptcy was filed, and to what extent the creditors of Sports Authority generally knew that Sports Authority was substantially engaged in the selling of the goods of others.
In its April 2019 article, “Protecting a Consignor’s Interests in Retail Bankruptcy,” attorneys Mike Shiner and Maribeth Thomas of the law firm Tucker Arensberg discussed the decision of Bankruptcy Judge Mary F. Walrath: “Judge Walrath ordered the consignor to turn over the proceeds of the sale of the consigned goods because Sports Authority’s total inventory available for sale to its customers never included more than 14% of consigned merchandise.” Under the Uniform Commercial Code (UCC), which governed the transactions, Judge Walrath held that Sports Authority was not “substantially engaged” in consignment sales because its sale of the consigned goods was below the 20% threshold recognized by courts as satisfying the UCC’s requirement of substantial engagement for purposes of Section 9-102(a)(20)(A)(iii). Essentially, Section 9-102(a)(20)(A)(iii) operates as an exception to the definition of a “consignment,” and, thus, the applicability of the UCC to such transaction, where creditors of the borrower/merchant generally know it to be substantially engaged in selling the goods of others (the “UCC Exception”). Here, because only 14% of Sports Authority’s inventory constituted consigned goods, the court found that the debtor was not substantially engaged in the business of selling consigned goods; therefore, the UCC applied to the consignor for purposes of determining the priority of its security interest.
The article continued, “Based on this decision, and in light of the increase in retail bankruptcies, it is vital that consignors understand the provisions of the UCC that govern consignment sales to ensure full compliance with those rules.”
If a consignment does not satisfy the requirements of Section 9-102(a)(20), the relationship between the consignor and consignee is governed by common law, and the interest of the consignment seller would prevail over the interest of secured creditors. However, if the consignment falls within Section 9-102(a) (20) of the UCC, it is the UCC that applies to the relationship, and the consignor’s rights are substantially different. Under the UCC, the consigned goods are considered inventory of the consignee, and the consignor needs to file a financing statement to perfect its security interest. In that instance, to prevail over a secured lender who perfected its security interest first, the consignor would need to demonstrate that the consignee (in this instance, Sports Authority) was “generally known by its creditors to be substantially engaged in selling the goods of others” in order to trigger the UCC Exception and “take its interests outside the scope of the UCC.”
The article concluded, “Before entering into a consignment relationship, a consignor must clearly understand the law governing the transaction with the consignee, know what secured financing is in place with its customer, and take the necessary steps to perfect its security interest. Furthermore, in the retail bankruptcy setting, a lender should fully understand the nature of the business of the retail borrower to determine at the outset whether it is substantially engaged in consignment sales.”
Benjamin S. Seigel, Esq.
G & B Law, LLP
818-382-6200
