Recent Court decisions on consignments and other security arrangements: the benefits of aggressive creditor action and the pitfalls of failing to document properly!(Column)

In certain industries, vendors frequently enter into consignment arrangements to facilitate their sale of goods. In the typical consignment, the vendor/consignor delivers goods to the buyer/consignee, retains title to the goods and does not record a sale until the consignee reports that it sold or used the consigned goods or, if the consignment agreement provides, kept the goods on hand for a fixed period of time.

A consignor has enhanced rights to the goods delivered to the consignee so long as the consignor satisfies all the requirements for a protected consignment interest. However, rights can be easily lost if a consignment creditor fails to take aggressive action to collect and protect its claim in response to its customer's bankruptcy filing and also if the creditor fails to dot its "i's" and cross its "t's" in the documentation that creates and secures payment of its consignment claim.

The United States Bankruptcy Court for the District of Delaware, in In re Whitehall Jewelers, Inc., recently dealt with whether a Chapter 11 debtor could sell consignment goods free and dear of the interests of consignment creditors. The Bankruptcy Court refused to approve the sale without first ruling on whether the consigned goods delivered to Whitehall were property of Whitehall's bankruptcy estate. That required Whitehall to first commence separate lawsuits against each of the 124 consignment creditors to determine ownership of the consigned goods. The court's decision shifted the balance of power in the case in favor of the consignment creditors, thereby enabling them to reach a favorable resolution of their consignment claims.

In another case, the United States District Court for the Eastern District of Virginia, in In re the Holladay House, Inc., upheld the Bankruptcy Court's ruling that a consignment creditor had a prior perfected interest in only the inventory delivered under its consignment agreement with the debtor, and not also in all of the debtor's

other non-consigned inventory as the creditor had intended to obtain under its consignment and security agreement with the debtor. While the debtor had granted the creditor a security interest in all debtor's inventory in the consignment and security agreement, the creditor's UCC financing statement limited the creditor's perfected security interest to its consigned goods. The court's ruling illustrates the importance to a secured creditor of conforming the collateral description in its security agreement and Uniform Commercial Code (UCC) financing statement. Otherwise, the secured creditor will not be able to recover all the collateral it had bargained for. A real downer!

Consignments

In a consignment, the consignor retains rifle to the goods delivered to the consignee. Title usually passes to the consignee upon the consignee's use or sale of the goods. The consignor issues an invoice after the consignee's reported sale or use of the goods, and the consignee can return unsold or unused goods to the consignor.