Program
Secured Transactions/Secured Lending Subcommittees
(of the UCC/ComFin Committees)
Chicago
Sunday August 2, 10:30 – 12 noon
Delve into the mysteries of consignments between suppliers of raw
materials or equipment and their manufacturing customers, or between
manufacturers and their wholesale or retail dealers. Are consignments
Article 9 secured transactions? Or Article 2 sales transactions? Or
bailments? Or something else altogether? What about just-in-time inventory
arrangements and their title transfer provisions? Come learn all about
consignments and the like from a panel of experts:
Richard K. Brown, Winston & Strawn LLP.
Richard L. Goldfarb, Stoel Rives LLP
James D. Prendergast, First American Title Insurance Company
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THE MYSTERIES OF CONSIGNMENTS, SALE OR RETURN,
BAILMENTS, AND OTHER WAYS TO MYSTIFY THE TRUSTEE
IN BANKRUPTCY
I.
Panel Topic
a. Delve into the mysteries of consignments between suppliers of raw
materials or equipment and their manufacturing customers, or between
manufacturers and their wholesale or retail dealers. Are consignments
Article 9 secured transactions? Or Article 2 sales transactions? Or
bailments? Or something else altogether? What about just-in-time
inventory arrangements and their title transfer provisions?
b. Panel participants: James Prendergast of First American Title Insurance
Company, Richard Goldfarb of Stoel Rives and Richard Brown of
Winston & Strawn.
II.
Some Useful Definitions
a. Article 9 Scope
i.
§9-109. SCOPE. (a) Except as otherwise provided in
subsections (c) and (d), this article applies to: (1) a transaction,
regardless of its form, that creates a security interest in personal
property or fixtures by contract ... (4) a consignment.
ii.
Article 9 Looks to the Substance of the Transaction, Not Merely
its Form. Article 9 applies to “a transaction, regardless of its
form, that creates a security interest in personal property or
fixtures by contract,” per §9-102 (a) (1). No matter how parties
structure or label a transaction, if the transaction creates what is in
substance a security interest – that is, if it in substance creates “an
interest in personal property or fixtures which secures payment or
performance of an obligation,” per the definition of “security
interest” in §1-201 (37) – then a court will view the transaction as
creating a security interest and hence subject to Article 9.
iii.
In re American Home Mortgage (379 B.R. 503; 58 Collier
Bankr.Cas.2d; 49 Bankr.Ct.Dec 93; Bankr. L. Rep. P 81, 228; Jan 4.
2008):
“Under New York law, when interpreting a contract, the court
should arrive at a construction which will give fair meaning to
all of the language employed by the parties to reach a practical
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interpretation of the expression of the parties so that their
reasonable expectati0ons will be realized. ... Where the
intention of the parties is clearly and unambiguously set forth,
effect must be given to the intent as indicated by the language
used. Finally, where the contract is clear and unambiguous on
its face, the intent of the parties must be gleaned from within
the four corners of the instrument. If the contract is clear, the
court will not look further for meaning” (p. 17).
iv.
Official Comment Change to §9-109
2. Basic Scope Provision. Subsection (a) (1) derives from former
Section 9-102(1) and (2). These subsections have been combined and
shortened. No change in meaning is intended. Under subsection (a)
(1), all consensual security interests in personal property and fixtures
are covered by this Article, except for transactions excluded by
subsections (c) and (d). As to which transactions give rise to a
“security interest,” the definition of that term in Section 1-201 must
be consulted. When a security interest is created, this Article applies
regardless of the form of the transaction or the name that parties have
given to it. Likewise, the subjective intention of the parties with
respect to the legal characterization of their transaction is irrelevant to
whether this Article applies, as it was to the application of former
Article 9 under the proper interpretation of former Section 9-102.
Reporter’s Note: The amendment would clarify that Article 9 applies
when a security interest is created, even if the parties subjectively intend
otherwise.
v.
Lease or Disguised Security Interest? § 1-203. Lease
Distinguished from Security Interest. “The key is whether the
buyer/lessee is obtaining more than the right to possess or use the
goods for a period of time and whether the seller/lessor is
retaining a meaningful residual interest in the goods.”1
(a) Whether a transaction in the form of a lease creates a
lease or security interest is determined by the facts of each
case.
(b) A transaction in the form of a lease creates a security
interest if the consideration that the lessee is to pay the lessor
for the right to possession and use of the goods is an
obligation for the term of the lease and is not subject to
termination by the lessee, and: (1) the original term of the
lease is equal to or greater than the remaining economic life
1
Linda J. Rusch, Secured Transactions St. Paul: Thompson West, 2006), p. 8
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of the goods; (2) the lessee is bound to renew the lease for the
remaining economic life of the goods or is bound to become
the owner of the goods; (3) the lessee has an option to renew
the lease for the remaining economic life of the goods for no
additional consideration or for nominal additional
consideration upon compliance with the lease agreement; or
(4) the lessee has an option to become the owner of the goods
for no additional consideration or for nominal additional
consideration upon compliance with the lease agreement.
(c) A transaction in the form of a lease does not create a
security interest merely because: (1) the present value of the
consideration the lessee is obligated to pay the lessor for the
right to possession and use of the goods is substantially equal
to or is greater than the fair market value of the goods at the
time the lease is entered into; (2) the lessee assumes risk of
loss of the goods; (3) the lessee agrees to pay, with respect to
the goods, taxes, insurance, filing, recording, or registration
fees, or service or maintenance costs; (4) the lessee has an
option to renew the lease or to become the owner of the
goods; (5) the lessee has an option to renew the lease for a
fixed rent that is equal to or greater than the reasonably
predictable fair market rent for the use of the goods for the
term of the renewal at the time the option is to be performed;
or (6) the lessee has an option to become the owner of the
goods for a fixed price that is equal to or greater than the
reasonably predictable fair market value of the goods at the
time the option is to be performed.
(d) Additional consideration is nominal if it is less than the
lessee's reasonably predictable cost of performing under the
lease agreement if the option is not exercised. Additional
consideration is not nominal if: (1) when the option to renew
the lease is granted to the lessee, the rent is stated to be the
fair market rent for the use of the goods for the term of the
renewal determined at the time the option is to be performed;
or (2) when the option to become the owner of the goods is
granted to the lessee, the price is stated to be the fair market
value of the goods determined at the time the option is to be
performed.
(e) The "remaining economic life of the goods" and
"reasonably predictable" fair market rent, fair market value,
or cost of performing under the lease agreement must be
determined with reference to the facts and circumstances at
the time the transaction is entered into.
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vi.
True Sales Problems:
1. Debtor sells accounts with a face value of $25,000 to
Factor who pays $24,000. Debtor warrants that the
accounts are all fully collectable. Debtor agrees to pay
Factor the face amount of any account that cannot be
collected. Has Debtor sold all these accounts? If these
aren’t sales, what are they?
2. Debtor sells accounts with a face value of $24,000 to
Factor who pays $24,000. Debtor sells Factor a put
allowing Factor to sell back to Debtor accounts that cannot
be collected. Has Debtor sold all these accounts? If these
aren’t sales, what are they?
3. Debtor has a painting worth $10,000. Debtor sells painting
to Bank for that amount and Bank pays in cash. Debtor and
Bank further agree that Bank has the right to sell the
painting back to Debtor for $11,000 in one year. Describe
Bank’s position.
4. Debtor has a painting worth $10,000. Debtor sells painting
to Bank for that amount and Bank pays in cash. Debtor and
Bank further agree that Bank has the right to sell the
painting back to Debtor for $11,000 in one year. Debtor
and Bank further agree that Debtor has the right to buy the
painting back from Bank in one year for $11,000.
Difference?2
b. Consignments
i.
§9-102(19) "Consignee" means a merchant to which goods are
delivered in a consignment.
ii.
§9-102 (20) "Consignment" means 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
2
Randal C. Picker, Security Interests in Personal Property (New York: Foundation Press, 2009), p. 479480.
-5-
(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.
iii.
§9-102 (21) "Consignor" means a person that delivers goods to a
consignee in a consignment.
iv.
§ 2-104(1) "Merchant" means a person that deals in goods of the
kind or otherwise holds itself out by occupation as having
knowledge or skill peculiar to the practices or goods involved in the
transaction or to which the knowledge or skill may be attributed by
the person's employment of an agent or broker or other intermediary
that holds itself out by occupation as having the knowledge or skill.
v.
§9-102(44) "Goods" means all things that are movable when a
security interest attaches. The term includes (i) fixtures, (ii)
standing timber that is to be cut and removed under a conveyance or
contract for sale, (iii) the unborn young of animals, (iv) crops
grown, growing, or to be grown, even if the crops are produced on
trees, vines, or bushes, and (v) manufactured homes. The term also
includes a computer program embedded in goods and any
supporting information provided in connection with a transaction
relating to the program if (i) the program is associated with the
goods in such a manner that it customarily is considered part of the
goods, or (ii) by becoming the owner of the goods, a person
acquires a right to use the program in connection with the goods.
The term does not include a computer program embedded in goods
that consist solely of the medium in which the program is
embedded. The term also does not include accounts, chattel paper,
commercial tort claims, deposit accounts, documents, general
intangibles, instruments, investment property, letter-of-credit rights,
letters of credit, money, or oil, gas, or other minerals before
extraction.
c. Sale or Return
i.
§2-106(1). In this Article unless the context otherwise requires
"contract" and "agreement" are limited to those relating to the
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present or future sale of goods. "Contract for sale" includes both a
present sale of goods and a contract to sell goods at a future time.
A "sale" consists in the passing of title from the seller to the buyer
for a price (Section 2-401). A "present sale" means a sale which is
accomplished by the making of the contract.
ii.
§2-326. Sale on Approval and Sale or Return; Consignment Sales
and Rights of Creditors.
(1) Unless otherwise agreed, if delivered goods may be
returned by the buyer even if they conform to the
contract, the transaction is:
(a) a "sale on approval" if the goods are delivered
primarily for use; and
(b) a "sale or return" if the goods are delivered
primarily for resale.
(2) Goods held on approval are not subject to the
claims of the buyer's creditors until acceptance; goods
held on sale or return are subject to such claims while
in the buyer's possession.
(3) Any "or return" term of a contract for sale is to be
treated as a separate contract for sale under Section 2201 and as contradicting the sale aspect of the contract
under Section 2-202.
iii.
§2-327(2). Under a sale or return unless otherwise agreed(a) the
option to return extends to the whole or any commercial unit of the
goods while in substantially their original condition, but must be
exercised seasonably; and (b) the return is at the buyer's risk and
expense.
d. Bailment
i.
Delivery of personal property for safekeeping by another, with
control and possession passing from the bailor (the owner) to the
bailee. For example, personal items or stock certificates, held in
trust in a bank Safe Deposit Box. The bailee has no knowledge of
the items delivered and no fiduciary relationship is created, as in a
Trust agreement. http://www.answers.com/topic/bailment.
ii.
A bailment is the act of placing property in the custody and
control of another, usually by agreement in which the holder
(bailee) is responsible for the safekeeping and return of the
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property. Examples include securities left with the bank, autos
parked in a garage, animals lodged with a kennel, or a storage
facility (as long as the goods can be moved and are under the
control of the custodian). There are different types of bailments"bailments for hire" in which the custodian (bailee) is paid,
"constructive bailment" when the circumstances create an
obligation upon the custodian to protect the goods, and "gratuitous
bailment" in which there is no payment, but the bailee is still
responsible.
There is a lower standard of care imposed upon the bailee in a
gratuitous bailment, and the parties may contract to hold the bailee
free from liability in any bailment. As the law of bailments
establishes a lower standard of care for the bailee in a gratuitous
bailment agreement, such an agreement or receipt should indicate
explicitly that the bailee is acting without compensation.
When a bailment is for the exclusive benefit of the bailee, the bailee
owes a duty of extraordinary care. If the bailment is for the mutual
benefit of the bailee and bailor, the bailee owes a duty of ordinary
care. A gratuitous bailee must use only slight care and is liable only
for gross negligence.
To create a bailment, the alleged bailee must have actual physical
control with the intent to possess. Physical control and intent to
possess will be interpreted according to the expectations of the
parties. If a court thinks that liability would be unexpected or unfair,
it can usually find that the defendant did not have “physical control”
or “intent to possess.”
For example, courts are more likely to find a bailment of a car exists
in a garage with an attendant than in a park and lock garage.
http://definitions.uslegal.com/b/bailment/.
e. Property of the Bankruptcy Estate3
i.
Why Do We Care What Property Is in the Estate:
1. This property is available to creditors. Property not in the
estate is not.
2. This property is available to creditors. Property not in the
estate is not.
3. Property of the estate is protected by the automatic stay –
§ 362(a) (2), (4).
3
Content lifted from Professor Sepinuck’s Bankruptcy Syllabus 2009. Stephen comes to the ABA so
claiming authorship was too risky.
-8-
4. Trustee has various powers over property in the estate
(acquire possession – § 542; use, sell, or lease – § 363).
ii.
+
+
+
+
–
–
What Is Property of the Estate?
Any property of the debtor at the time of filing
(including property seized prepetition)
(including property subject to alienation restrictions
Property recovered as preference or fraudulent transfer
Life insurance and property debtor becomes entitled to
inherit w/in 180 days after petition
Interest, profits & proceeds of above
Property acquired by the estate
Property held in trust for another
Property constructively held in trust for another
Bankruptcy Estate
§ 541(a)(1)
§ 541(c)(1), (2)
§ 541(a)(3)
§ 541(a)(5)
§ 541(a)(6)
§ 541(a)(7)
§ 541(d)
§ 541(d)
f. PMSI
i.
Definitions:
1. § 9-103(a) (1) "purchase-money collateral" means goods
or software that secures a purchase-money obligation
incurred with respect to that collateral.
2. § 9-103(a)(2) "purchase-money obligation" means an
obligation of an obligor incurred as all or part of the price
of the collateral or for value given to enable the debtor to
acquire rights in or the use of the collateral if the value is in
fact so used.
ii.
A security interest in goods is a purchase-money security interest:
1. to the extent that the goods are purchase-money collateral
with respect to that security interest;
2. if the security interest is in inventory that is or was
purchase-money collateral, also to the extent that the
security interest secures a purchase- money obligation
incurred with respect to other inventory in which the
secured party holds or held a purchase-money security
interest; and
3. also to the extent that the security interest secures a
purchase-money obligation incurred with respect to
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software in which the secured party holds or held a
purchase-money security interest.
iii.
The security interest of a consignor in goods that are the subject
of a consignment is a purchase-money security interest in inventory.
iv.
In a transaction other than a consumer-goods transaction, a
purchase-money security interest does not lose its status as such,
even if:
1. the purchase-money collateral also secures an obligation
that is not a purchase-money obligation;
2. collateral that is not purchase-money collateral also secures
the purchase-money obligation; or
3. the purchase-money obligation has been renewed,
refinanced, consolidated, or restructured.
v.
In a transaction other than a consumer-goods transaction, a
secured party claiming a purchase- money security interest has the
burden of establishing the extent to which the security interest is a
purchase-money security interest.
vi.
§9-324(a) Except as otherwise provided in subsection §9-324(g),
a perfected purchase-money security interest in goods other than
inventory or livestock has priority over a conflicting security
interest in the same goods, and, except as otherwise provided in
Section 9-327, a perfected security interest in its identifiable
proceeds also has priority, if the purchase-money security interest is
perfected when the debtor receives possession of the collateral or
within 20 days thereafter.
vii.
Subject to §9-324(c) and except as otherwise provided in
subsection §9-324(g), a perfected purchase-money security interest
in inventory has priority over a conflicting security interest in the
same inventory, has priority over a conflicting security interest in
chattel paper or an instrument constituting proceeds of the inventory
and in proceeds of the chattel paper, if so provided in Section 9330, and, except as otherwise provided in Section 9-327, also has
priority in identifiable cash proceeds of the inventory to the extent
the identifiable cash proceeds are received on or before the delivery
of the inventory to a buyer, if:
1. the purchase-money security interest is perfected when the
debtor receives possession of the inventory;
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2. the purchase-money secured party sends an authenticated
notification to the holder of the conflicting security interest;
3. the holder of the conflicting security interest receives the
notification within five years before the debtor receives
possession of the inventory; and
4. the notification states that the person sending the
notification has or expects to acquire a purchase-money
security interest in inventory of the debtor and describes the
inventory.
viii.
If more than one security interest qualifies for priority in the same
collateral under §9-324(a), (b), (d), or (f):
1. a security interest securing an obligation incurred as all or
part of the price of the collateral has priority over a security
interest securing an obligation incurred for value given to
enable the debtor to acquire rights in or the use of
collateral; and
2. (2) in all other cases, Section 9-322(a) applies to the
qualifying security interests.
ix.
III.
“In most circumstances identification of a purchase money
security interest is easy. If the seller has retained an interest in
goods sold to secure payment of some or all of the price, the seller
has a purchase money security interest whether the agreement with
the buyer is called “a conditional sales contract,” a “bailment
lease,” or something else.”4 True?
More on Consignments5
Applicability of Article 9 to Consignment Transactions
a. “Consignment” is a business arrangement of ancient vintage. A
consignment is a transaction in which a person delivers goods to a
merchant for the purpose of having the merchant sell the goods on behalf
of the consignor. Thus, a consignment is a species of bailment: it is a
bailment of goods to a merchant, coupled with a grant of power to the
merchant to sell the goods.
4
James J. White and Robert S. Summers, Uniform Commercial Code (St. Paul: West Group, 2000), p. 760.
5
Lifted from Ken Kettering’s Syllabus for his Secured Transaction’s class.
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b. As an example of a consignment transaction, suppose that O (for “owner”)
owns a valuable painting that O wishes to sell. O has a friend, M (for
“merchant”), who owns an art gallery. O might enter into a consignment
arrangement with M. Under the arrangement O would deliver the painting
to M, who would hang it in his gallery, and M would have authority from
O to sell it. If M does sell it, M would be entitled to retain an agreed
commission, and would pay the balance of the sale price to O. The
painting remains O’s property until sold, however, and if it isn’t sold M
would ultimately return it to O, with no liability on M’s part to O.
Consignment is a common method of distributing goods in bulk in some
industries. For instance, it is not uncommon for a manufacturer or
wholesaler of textiles to sell them through a consignment arrangement
with a retailer, the manufacturer/wholesaler playing the role of O in the
above example and the retailer playing the role of M.
A consignment transaction such as the one just described is not a lien
transaction. But if the terms are bent a bit, a consignment might become
economically indistinguishable from a lien transaction, to the degree that
the so-called consignment should be recharacterized as a lien transaction.
To illustrate this, suppose that instead of O and M entering into the
consignment just described, they enter into the following arrangement: O
sells the painting outright to M, on 100% credit (i.e., M pays no money
down); O retains a security interest in the painting to secure M’s
obligation to pay the price. Economically, what difference is there
between that arrangement and the consignment arrangement?6 The most
important difference is that in the consignment M doesn’t have to pay O
for the painting unless M sells it, while in the sale-with-retainedsecurity-interest arrangement M will have to pay O for the painting on the
agreed payment date, whether or not M has sold the painting.
c. A consignment agreement is at risk of being recharacterized as a salewith-retained-security-interest, therefore, if the agreement between M and
O contains terms that have the effect of making M pay for the goods
whether or not M has sold them. In real life Ms and Os often do agree to
provisions that require M to pay for the goods in at least some
circumstances. And so it is often difficult to tell whether a given
consignment is a true consignment or should be recharacterized as a lien
transaction.7
6
Notice that in the sale-with-retained-security-interest transaction, M’s profit (that is, the difference
between the price M is obliged to pay O and the higher price at which M resells the painting) is
economically equivalent to the commission that M is entitled to retain in the consignment arrangement.
7
It is common to use the word “true” to denote a transaction that should not be recharacterized as a lien
transaction. Thus, one may speak of a “true consignment,” a “true lease,” or a “true sale (of receivables).”
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In order to minimize the need to determine whether a given consignment
is a true consignment or a disguised lien transaction, the 1999 revision of
Article 9 was drafted to govern true consignments. Section 9-109(a)(4)
provides that Article 9 applies to consignments; “security interest” is
defined in §1-201(37) to include the consignor’s ownership interest in
consigned goods; and the terms “debtor” and “secured party” are defined
in 9-102(a) to include consignee M and consignor O, respectively, in a
consignment.
It is important not to be confused by this drafting trick into thinking that
all consignment transactions are lien transactions. Article 9 applies to a
consignment transaction whether the transaction is a true consignment or a
disguised lien transaction. Of course, when Article 9 uses the term
“consignment,” it is referring to a true consignment. A so-called
consignment that is economically equivalent to a lien transaction will be
treated just like any other lien transaction, and is not a “consignment”
within the meaning of Article 9.
The main consequence of the inclusion of true consignments within
Article 9 relates to the priority of O in the consigned goods against a third
party who claims an interest in the consigned goods in M’s hands, such as
a creditor of M. The key point is that in order for O to attain priority over
such a third party, O must perfect its ownership interest in the consigned
goods, by filing a financing statement against M. If O fails to perfect its
ownership interest, O’s rights in the consigned goods in all likelihood will
be trumped by the rights of M’s creditors (including M’s trustee in
bankruptcy).
IV.
A Concise Overview from Steve Harris:8
Before the revision of Article 9, some of the UCC’s consignment provisions
were in §2-326 and others were in §9-114. As comment 4 to revised §2-326
indicates, the revision of Article 9 consolidated these provisions, in a slightly
modified form, in Article 9. The goal was to make the provisions easier to
comprehend and apply. And, as was true before the revision, parties who
engage in a transaction with little or no documentation will increase the
difficulty of proving the terms of the transaction and, thus, its legal
characterization.
If a transaction does not fall within the definition of “consignment” in Article
9, it may be a sale or return. Or it may not be. By definition, a transaction is
not a sale or return unless the buyer can return the goods. As comment 1 to
§2-326 confirms, a “sale or return” is a sale. If a transaction contemplates
delivery to a buyer, who will resell them, it may be a sale or return. However,
8
[email protected]; on behalf of; Harris, Steven [[email protected]] Thu 1/22/2009
1:02 PM
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if the transaction contemplates delivery to someone who does not buy or
contract to buy them from the person making delivery, the transaction is not a
sale or return.
Suppose, then, that a true consignment (i.e., a delivery not to a buyer but to a
nonbuyer/consignee for the purpose of sale) is excluded from Article 9. Nonarticle 9 law determines the rights of creditors of the consignee. The common
law normally provides that a creditor can reach only the property of its
debtor. What property interest, if any, does a consignee under a typical
consignment enjoy? A consignment typically is considered a “bailment,”
which Justice Story defined as “a delivery of a thing in trust for some special
object or purpose, and upon a contract express or implied, to conform to the
object of the trust.” J. Story, Commentaries on the Law of Bailments § 2 (6th
ed. 1856). Professor Williston defined “bailment” even more broadly as “the
rightful possession of goods by one who is not the owner.” 4 Williston &
Thompson, Law of Contracts § 1032 (rev. ed. 1936). (Note that sometimes, as
in In re Morgansen’s, the term is limited to those deliveries for a special
purpose where the person taking delivery must return the goods.) A bailee
enjoys a “special property” in the bailed goods. The consignee’s creditors can
reach no more than that limited interest. Some courts might say that the
consignee’s right to possession is not a sufficient property interest in the
goods for a lien to attach to them. Regardless of the approach, the owner’s
(consignor’s) rights are superior to those of the consignee’s creditors.
Of course, some states may change these rules by statute, but in the absence of
a statute, the consignor’s rights against a creditor of the consignee should be
no different from the consignor’s rights against the consignee itself.
V.
An Intriguing Hypothetical
a. Suppose Consignor delivers silver bullion (.999 pure) to Sterling Silver
Manufacturer (SSM), under a document that says it is a ”consignment"
and allows for return of the bullion within 6 months. The "consignment"
agreement allows the bullion to be commingled, in the ordinary course of
business. Consignor files a financing statement and its "consignment
agreement" includes a granting clause describing the bullion. SSM
combines the silver with copper to make sterling silver (.925 silver) and
then manufactures it into tea sets. Secured Party 1 makes a loan, takes a
security interest in all "tea set inventory" and files a financing statement
on January 1, 2007. On July 1, 2007, Consignor files a financing
statement, does a search and sends a notice to everyone that has filed a
financing statement against SSM stating that Consignor will be selling
silver bullion to SSM on consignment. On August 1, 2007 Consignor sells
silver to SSM. By September 1 that silver was made into tea sets (but not
yet sold to SSM's customers).
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i.
Can the "consignment" be a true consignment if the consignee is
allowed to convert the asset into a form where it cannot be returned
to the consignor?
ii.
Once the silver becomes commingled, first with copper to become
sterling silver, and then is processed to become a tea set, is it still
"purchase money goods"?
iii.
Asking (ii) another way, in a priority fight between Secured Party
1 and Consignor that arises after all the silver has been made into
tea sets, who has priority? Is it consignor as the holder of a
purchase money security interest in the silver inventory (and then as
the holder of a security interest in the "product" under 9-336)? Or,
is it Secured Party 1, as the secured party that filed first (and does
not get its security interest under 9-336), as covered by the example
in Official Comment 7 to 9-336?9
b. Richard Newman’s response: With regard to Steve's questioning whether
the transaction involves a consignment, see In re Georgetown Steel
Company LLC, 55 UCC Rep Serv 2d 475, 318 B.R. 352, 2004 WL
2861761. The case involved a railroad consignor who provided shipments
of hot briquetted iron ("HBI") to a consignee steel mill, for the purpose of
the consignee's incorporating the HBI into its manufactured steel products
which it then offered for sale. The court decided that (a) the steel mill
took the HBI "for the purpose of sale," (2) the mill "dealt in goods of that
kind" and (3) the agreement between the railroad and the mill did not
create a security interest "that secures an obligation". The court decided
that the mill could combine the HBI with other components to produce its
finished product and still meet the "purpose of sale" requirement. It also
decided that, although the finished product was not the same HBI that was
delivered to it, the mill nevertheless "dealt in goods of that kind.
But even if it isn't a consignment (i.e., assume a "classic" PMSI claimed
by a lender) the PMSI/commingled goods issue still exists. I agree with
Cynthia's view that the party with the PMSI in the pure silver should have
a first priority claim for the value of its collateral. Of course, valuing the
collateral once the product or mass has been created is a separate issue.10
9
From: [email protected] [mailto:[email protected]] On Behalf Of
Cynthia Baker. Sent: Monday, January 12, 2009 9:11 PM. Subject: [Ucclaw-l] Consignments, PMSIs and
Commingled Goods
10
[email protected]; on behalf of; Newman, Richard M.
[[email protected]] Wed 1/14/2009 7:36 AM
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VI.
Some Interesting Cases
a. 9-103(a)(20)(A)(i): The Case of the High-End Jeweler
In re G.S. Distribution, Inc., 331 B.R. 552 (Bankr. S.D.N.Y. 2005).
Imagine yourself on Madison Avenue in New York and you pass what appears to be a
high-end jewelry store with a fancy Italian name on it. Do you think to yourself, “this
store must be owned by the jeweler with the fancy Italian name,” or do you think “I’ll bet
I’d be dealing with someone other than the fancy Italian name, like a franchise or a
consignor”? And wouldn’t you be surprised to learn that that business actually had no
right to sell you any jewelry at all in the United States?
This is the case of G.S. Distribution. A man named Giuseppe Scavetta decided to go into
the jewelry business on Madison Avenue in 2003, despite having no prior experience in
jewelry. He started by selling jewelry from a company called Ciribelli, but by September
2004 he had sold only a tiny amount of Ciribelli jewelry and so instead entered into an
agreement with a company called Repossi to sell its jewelry. The agreement between
Scavetta’s company and Repossi included the following term (in, as the court put it,
“somewhat broken English):
Upon mutual agreement collection, Repossi Diffusion shall
make available Repossi Jewelry to [G.S. Distribution] on a
consignment basis subject to the terms and conditions of
this Article. Such consignment of Repossi Jewelry is
expected to be made for sale promotion to important
customers, private visits, exhibitions, and show cases.
Interestingly, all this jewelry was imported into the United States under a special customs
arrangement, “Temporary Importation under Bond” or “TIB.” The result of that was that
the jewelry could not be sold to anyone in the United States without violating the customs
laws.
Nonetheless, Scavetta sold, according to him, about $500,000 worth of Repossi jewelry
from his Madison Avenue store and through Saks Fifth Avenue. And in keeping with the
grand traditions that support the bankruptcy bar, he never paid Repossi a dime for its
jewelry. And of course Repossi didn’t file a financing statement to protect its rights in
the jewelry.
In bankruptcy, the critical question became whether the arrangement with Repossi
constituted a “consignment” or a “sale or return” under 9-103(a)(20) or 2-326,
respectively. The court held that it was not a consignment within the meaning of Article
9 because G.S. Distribution did not “deal in goods of that kind under a name other than
the name of the person making delivery” as required by 9-103(a)(20)(A)(i). The reason
for that requirement is that “[w]here a consignee operates only under the name of the
consignor, the U.C.C. assumes that the consigee’s general creditors will be on notice of
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the consignment and will not be misled into believing that the merchant has ownership of
the inventory in its possession.”
In this case, “Debtor held itself out to the public as a Repossi store;” moreover, the only
significant general creditor was Scavetta himself, “and he certainly knew the facts.”
As to whether the jewelry was held on “sale or return”, the fact that the jewelry could not
legally be sold in the United States sank the debtor’s claim that 2-326 would make it
property of the estate. “The Court will not construe the Contract in a way that would
violate the customs laws by finding that the consigned jewelry was imported for sale
rather than for a lawful purpose.”
b. 9-102(a)(20)(a)(iii): The Case of the Big Pile of Compact Discs
In re Valley Media, Inc., 279 B.R. 1056 (Bankr. D. Del. 2002).
The way people make money (or fail to make money) in the music industry has been a
topic of significant public interest since the invention of digital media and the ability to
make perfect copies (instead of, say, sticking a microphone for a reel-to-reel tape in front
of your stereo speakers, which is how my brother recorded “Star Trek”). Bankruptcy of
companies involved in certain aspects of the business is not uncommon. Valley Media
was one such company. It had staked its future on being a distributor of physical
inventory of music compact discs, and the new economy worked its black magic on it.
Before, as we will see, working even blacker magic on those unfortunate enough to have
supplied it.
Those who had consigned their inventory to Valley Media didn’t even believe they were
dealing with Valley Media. Instead, they contracted with a division of Valley Media
called DNA.
At least from the opinion, the distribution contracts Valley Media entered into, which
were purportedly standard in the industry, were quite favorable to it. They included an
unfettered right to return unpaid merchandise, the duty on the vendors’ part to pay all
royalties due to the copyright holders and to indemnify for infringement, and, with regard
to the so-called consigned inventory, no need to pay until the goods were sold. When the
distributor went belly-up, the consignors discovered how bad their position was.
Naturally, none of them had filed a financing statement. Thus, the court held that the
inventory would be property of the estate unless the consignors could prove that their
consignee was “generally known by its creditors to be substantially engaged in selling the
goods of others” within the meaning of former 2-326(3) and current 9-102(a)(20)(iii).
And they had a huge obstacle to overcome: DNA’s status as merely a division of Valley
Media. While there was some evidence that DNA’s main business was performed as a
consignee, this wasn’t true of Valley Media as a whole. And the court was
unsympathetic to the idea that the critical language in the definition of “consignment”
applied to anything other than the actual legal entity.
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The creditors to be protected by treating Article 9 consignments as purchase money
security interests are those who might be fooled by a “secret lien.” As the court said,
“The purpose of [the statute] is to protect general creditors of the consignee from claims
of consignors that have undisclosed consignment arrangements with the consignee that
create secret liens in inventory.” When someone is “generally known” to be selling
others’ goods, the creditors cannot expect that the inventory on the shelves in the
warehouse will be available to satisfy their claims.
The court emphasized the evidentiary difficulty faced by whoever had the burden of
proof on the question of whether an entity is “generally known by its creditors to be
substantially engaged in selling the goods of others.” And in fact the consignors were
unable to meet this burden, either on a statistical basis (the case law threshold for the
percentage of goods consigned is, the court found, 20%, and Valley Media had only
17.03% of its goods subject to consignment) or on a factual basis, since they offered no
evidence of what the general creditors believed.
c. 9-102(a)(20)(A)(ii)&(iii) and (C) and 2-326(b): The Case of
Grandma’s Pearls
In re Morgansen’s Ltd., 302 B.R. 784 (Bankr. E.D. N.Y. 2003).
Southampton on Long Island is not where you think about bankruptcy much, at least not
in 2003. But Morgansen’s, a shop “selling various expensive items such as jewelry, art,
collectibles and
furniture” in Southampton did file in February of that year. The shop had a brisk
business in the summer, but in the other seasons of the year it was open only a few days a
week and subsisted on making sales to interior decorators.
A lot of Morgansen’s inventory was on what the people who entrusted it with goods
would have called consignments, and which its documentation with them called
consignments. The arrangement was the usual one for such shops, where the person
bringing in grandma’s pearls, or the old Currier & Ives prints or the Louis Quinze chairs
would leave the goods with Morgansen’s, which would choose whether to sell them in
the shop or at auction, and when sold was expected to remit the proceeds to the
consignor, less its commission.
Not surprisingly, the people who had consigned their goods with Morgansen’s in this
manner objected with the trustee filed a motion in the bankruptcy case to sell the whole
lot at public sale.
The court went through an interesting, and possibly flawed, analysis of the applicability
of 9-103(a)(20). The focus was on two provisions, 9-103(a)(20)(ii), which excludes the
inventory of an auctioneer, and 9-103(a)(20)(iii), discussed at length in the Valley Media
case. The court ruled that Morgansen’s was not an auctioneer, despite the big sign
outside that said “auctions” and the right in the consignment agreement to sell consigned
goods at auction. The court also found that Morgansen’s, for reasons similar to those
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used in Valley Media was not generally known to its creditors to be substantially engaged
in selling the goods of others. Again, this appeared to be more for want of proof than
anything else. It is hardly in the best interests of a general creditor to admit that it knew
the debtor was exempt from being a consignee when the result of silence is to increase
the pot of money available for general creditors.
The other question, which the court did not appear to address, is whether the goods were
consumer goods immediately before delivery, which would take the transaction out of
Article 9 on the basis of 9-102(a)(20)(C).
The court did go on to address 2-326 and found that the goods were indeed subject to
“sale or return” treatment, and therefore were property of the estate.
Under UCC Section 2-326 as amended, goods which are
consigned for sale, are property of the bankruptcy estate of
the "consignee," and subject to the claims of the creditors
of the entity doing the sale (Morgansen's). If a person takes
goods to one who is considered a consignee (a "buyer" for
resale) and that buyer files for bankruptcy relief, the
buyer/debtor's trustee will take the goods as property of the
debtor's estate. Under section 544(a) of the Bankruptcy
Code, these goods may be sold by debtor's trustee.
Again, the only recourse was to have filed a financing statement.
d. The Case of the Lazy Art World
Hilary Jay, A Picture Imperfect: The Rights of Art Consignor-Collectors When
Their Art Dealer Files for Bankruptcy, 58 Duke L.J. 1859 (2009).
The cliché goes, “He knows nothing about art, but he knows what he likes.” James
Thurber even turned it around into a famous cartoon, “He knows all about art, but he
doesn’t know what he likes.” In her article, Ms. Jay argues that the art world knows
nothing about the Uniform Commercial Code, but it doesn’t like what it’s getting from it.
The problem appears to be that the UCC’s treatment of consignments doesn’t fit well into
the “‘often-byzantine financial maneuvering’ of the art world.” Art dealers may be
showing works from their own inventory, works consigned from the artist, works
consigned from collectors and work on loan for the purpose of display and not for sale.
The percentage that a particular dealer may have of each category will vary from time to
time. This is art, after all, not “screwdrivers in a shop.” And the art world claims a
peculiar allergy to paperwork. While a manufacturer or distributor might be willing to
invest a small sum in a financing statement to provide superpriority over competing
creditors, the consignor of a Picasso apparently is not.
The article does note that 31 states have special statutes that confer special rights on
mainly artists. Collectors, on the other hand, are frequently not included in the coverage
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of such statutes. Many apparently do not expressly refer to or preempt the UCC
(although the one in Washington, Wash. Rev. Code ch. 18.100 does; see Wash. Rev.
Code 62A.1-110, a non-uniform provision in Article 1 that expressly states that the art
dealers’ statute preempts any provision of the UCC).
The article suggests that Article 9 be amended, perhaps by placing the burden of proof on
the art gallery to show that it was not generally known to be substantially engaged in the
sale of the goods of others.
The article also does a good job of explaining how, in the absence of coverage under
either Article 9 or Article 2, the common law of bailment would apply. See In re Guild &
Gallery Plus, Inc., 72 F.3d 1171 (3d Cir. 1996), holding that while the contract of
bailment was property of the estate, the painting itself, which was subject to a common
law bailment, was not. See also In re Haley & Steele, Inc., 2005 WL 3489869 (Mass.
Super. Ct. 2005).
e. 9-102(a)(20): The Case of That Thing That Goes Into That Other
Thing
In re Georgetown Steel, Inc., 318 B.R. 352 (Bankr. D. S.C. 2004)
Hot briquetted iron (“HBI”) is one of those things that no one outside the steel industry
will know much about. There is actually a Hot Briquetted Iron Association
(www.hbia.org), which lists six members, 16 “associates” and eight ‘traders”. A clubby
niche industry, in other words.
One of those associate members is Progress Rail Services, a subsidiary of Caterpillar. It
supplied HBI to Georgetown Steel, which, as the case name indicates, later went
bankrupt. Under Progress Rail’s agreement with Georgetown Steel, the HBI was kept
separate from Georgetown Steel’s other inventory, and removed on an as-needed basis, at
which point Progress Rail would invoice Georgetown Steel. Like every other losing
consignor here, Progress Rail did not file a financing statement.
CIT had a first position perfected security interest in Georgetown Steel’s inventory.
When Georgetown Steel filed for bankruptcy protection, the mill closed and there was no
need for the HBI on its premises, so it was stipulated that the HBI would be sold and the
court would determine who had rights to the proceeds.
The parties agreed that most of the criteria in 9-102(a)(20) to classify the transaction as a
consignment were met, with the main exception that Progress Rail claimed that the HBI
was not supplied to Georgetown Steel “for the purpose of sale.”
It’s not hard to understand Progress Rail’s position. The only people who would be
holding on to HBI “for the purpose of sale,” using the ordinary meaning of the term,
would be the six members, 16 associates and eight traders in the Hot Briquetted Iron
Association. The people to whom they would sell HBI, other than to one another, would
be steel mills. Steel mills, in turn, wouldn’t be selling HBI, they would be incorporating
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HBI into steel. So, the argument, concludes, this wasn’t an Article 9 consignment and
the failure to file a financing statement should not be fatal to Progress Rail’s rights to the
HBI.
Unfortunately for Progress Rail, it didn’t work out that way. The second paragraph of
comment 14 to 9-102 describes what “for the purpose of sale” means for the purpose of
9-102(a)(20), and that purpose is a lot broader than Progress Rail’s argument.
The definition of “consignment” requires that goods be
delivered “to a merchant for the purpose of sale.” If the
goods are delivered for another purpose as well, such as
milling or processing, the transaction is a consignment
nonetheless because a purpose of delivery is “sale.”
In other words, the “purpose of sale” essentially means “the purpose of sale or the
purpose of being incorporated into something else that will be sold.”
Progress Rail had four other arguments, which the court similarly dismissed. First, it
argued that Georgetown Steel wasn’t a merchant, and therefore 9-102(a)(20) didn’t apply
to it, because it didn’t “deal in goods of that kind.” The court held that one who
purchases a raw material for incorporation into a product it sells in its business deals in
goods of that kind. Second, it argued that the transaction did not secure an obligation,
thus coming under the exception in 9-102(a)(20)(D). The court had little trouble deciding
that since Progress Rail expected to be paid its unpaid purchase price, that price was an
obligation. Third, it argued that the transaction came more properly under Article 2 than
Article 9. The difficulty Progress Rail had there was that it had drafted its contract too
well. Since, under its contract, the actual sale occurred when the HBI was taken out of
inventory and consumed by Georgetown Steel, it was not allowed to argue that there was
a sale when the HBI was not taken out of inventory. Finally, it argued that the contract
was merely a bailment and Georgetown Steel was its agent. But that didn’t work either
because there was nothing in the contract that would require the HBI to be returned to
Progress Steel.
Essentially, this was a just-in-time supply agreement, the cutting edge of the 80s, the
mainstay of the 90s and the old-hat of the 00s. And the basic lesson of Article 2 and
Article 9 for a just-in-time supply agreement is to file a financing statement and make it a
purchase money security interest in inventory, 9-103(d).
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