Consignment Done Right: Perfect and Notify for Enforceable Rights in Bankruptcy

Introduction

Consignment is a business arrangement between a vendor (known as the consignor) and a customer (known as the consignee). Consignees include retailers that specialize in a particular type of consumer product, such as clothing, shoes, athletic equipment and gear, as well as other customers in the business of selling consigned goods. Alternatively, customers can use the consigned goods in their possession in the production of finished goods and defer payment until after usage.

Customers that enter into consignment arrangements may benefit from the ability to offer a wider range of products, potentially drawing in new business and higher profits. The customer’s operational financial risk is also greatly reduced compared to wholesalers and retailers that pre-purchase their entire inventory in the hopes of then selling the goods to retail consumers. Customers may also benefit from payment timing and cash flow because the purchase price of the consigned inventory is not paid for until the inventory is actually sold to the retail consumer.

Similarly, consignors may benefit from a consignment arrangement by obtaining higher visibility of their new product brands and gaining additional sales channels for proven products. The consignment arrangement may also significantly reduce the consignor’s product storage costs by transferring the physical possession of the consigned goods to the consignee pending sale to consumers. Consignors may also enjoy the protections that Article 9 of the Uniform Commercial Code (UCC) provides to consignors that properly document, perfect and provide advance notice with respect to their consignment arrangements. So, what happens when a consignor does not “dot its Is” and “cross its Ts”, by failing to comply with UCC Article 9’s consignment requirements?

UCC Article 9 governs most consignment transactions and generally requires vendors to satisfy specific requirements in order to retain a superior interest in the consigned inventory. When vendors diligently complete the steps required by the UCC, they will gain priority over prior creditors with a blanket security interest in the customer’s inventory and maintain priority over subsequent creditors with a security interest in the customer’s inventory and unsecured creditors. However, vendors that fail to comply with the UCC Article 9’s consignment requirements, including timely filing a UCC-1 financing statement in the appropriate jurisdiction, and providing the requisite advance notice of the consignment arrangement to all secured parties with a prior blanket security interest in the customer’s inventory, risk forfeiting their superior rights in the consigned inventory and being relegated to holding a low priority general unsecured claim.

The enforceability of a vendor’s consignment rights is often tested once a customer files for bankruptcy. The vendor’s due diligence, preparation of the proper documentation for execution by the customer, perfection by filing a UCC-1 financing statement and advance notification of the consignment arrangement to existing creditors with a blanket inventory lien, as well as prompt actions the vendor should take to enforce its consignment rights following the filing of its customer’s bankruptcy case, will often determine the extent of the consignor’s recovery.

This article reviews three relatively recent decisions from the U.S. Bankruptcy Court for the District of Delaware arising from the Chapter 11 bankruptcy case of The Sports Authority Holdings, Inc. (“Sports Authority”). These decisions provide insightful guidance concerning the consequences of failing to properly perfect a consignor’s rights and provide the required notice under the UCC, as well as some creative arguments consignors have raised in the absence of compliance with the UCC’s filing and notification requirements in seeking recovery of its consigned goods and recovery on its consignment claim.