It is becoming increasingly common for trade creditors to deliver goods or to make goods available to their customers before they are technically “sold.” The idea is to put a volume of goods in the hands of customers for ease of access as needed. These transactions are frequently documented with consignment or warehouse agreements reciting that title remains in the seller. No sale is booked until the customer reports that the customer pulled and sold or used the consigned product. Sales by consignment are sometimes intended to be a security device to increase the likelihood of payment from a troubled customer. However, a seller placing goods in the hands of a customer prior to sale must take specific actions under the UCC to protect its interest in the goods. Failing that, a bankruptcy filing by the customer effectively transfers title to the bankruptcy trustee and subjects the goods to seizure by the customer’s bank lender holding a lien on all inventory. This Article analyzes the effect of the revisions to Article 9 of the UCC and reviews changes in current law relating to consignments or warehouse agreements. Under the re-visions, all consignments are governed by Article 9. Consequently, if a consignor fails to file UCC financing statements correctly and to jump through other required hoops, the consignor may end up last in line with a general unsecured claim against the consignee and loss of the goods.

What Is a Consignment?

In a consignment, the consignor retains title to the goods following delivery to the consignee. Traditionally, consignment was used when retail goods were placed with a retailer for sale, but the original owner retained title until the goods were sold. At that point, the consignor’s rights attached to the proceeds. In today’s business climate, the practice has greatly expanded so that commercial manufacturers (consignors) put inventory in the hands of their customers (consignees) so that it can be accessed as needed. Herein lies great risk!

Among other things, the consignee may hold the goods for sale or use, may use the goods as a finished product, may pull the goods from a consigned inventory of finished goods to service its customer base, or may pull from an inventory of equipment parts as needed to keep heavy equipment in production. If the consignee cannot sell or use the goods, the consignee usually has the right to return the goods to the consignor. The consignee theoretically obtains title to the consigned goods upon the consignee’s use or sale of the goods. At the point of “use” (i.e., when goods are pulled from stock), the consignor usually issues an invoice containing payment terms. 

All consignments are governed by each state’s UCC. Section 2-326(1) of the UCC recognizes two types of consignments:

• “Sale or Return” - The consignor delivers goods to the consignee primarily for resale, and title is transferred to the buyer upon delivery, but the buyer has a 
  contractual right to return the goods.
• “True Consignment” or “Sale on Approval” - The consignor delivers goods primarily for use by the consignee but retains title. The consignee may be holding the goods on a trial basis to determine whether it needs the goods or may be pulling them from stock as needed.

The two types of transactions are very similar in that in both cases the buyer/consignee is free to return the goods even though they conform to the contract. The conceptual distinction between the two is that a sale-or-return transaction is a present sale and the recipient of the goods is a “buyer,” whereas there is neither a present sale nor a buyer in a true consignment. Because of this distinction, under the old UCC, goods held on approval were not subject to the claims of the consignee’s creditors until acceptance, and the consignor did not need not take any action to protect its interest in the goods. Goods held on a “sale or return” basis were subject to the claims of the consignee’s creditors while in the 
consignee’s possession. 

Changes to the UCC Treatment of Consignments

• Changes to Article 9 for “Sale or Return” Consignments 

Prior to the revisions to UCC Article 9, former UCC § 2-326(3) identified two exceptions to the general rule that goods delivered on a sale or return basis were subject to the claims of the consignee’s creditors. A consignor that either (1) proved that the consignee was generally known by its creditors to be substantially engaged in selling the goods of others, or (2) complied with the Article 9 UCC filing requirements, had a superior interest in the consigned goods.¹ By satisfying either of these exceptions, the consignor gave sufficient notice of its interest to have a prior right to the goods.

The Article 9 revision radically changed the way the Uniform Commercial Code addresses consignments by moving the treatment of most such transactions from Article 2 into Article 9. Revised Article 9 did so by repealing old UCC § 2-326(3), meaning that only Revised Article 9 of the UCC now governs the treatment of most “sale or return” consignments. The primary effect of the revision is to treat consignments like purchase-money security interests in inventory. This means that the purported consignor must perfect its interest in order to establish priority and cannot merely recover the consigned goods upon the consignee’s default. Instead, the purported consignor must comply with the Article 9 repossession and sale rules. Thus, unless the purported consignee consents to a strict foreclosure, the purported consignor must conduct a UCC sale of the goods and account to the consignee if the sale produces a surplus.

• Changes to Article 9 for “True Consignments”

Because the scope of Revised Article 9 has been expanded to apply to “consignments,” a term that is broadly defined to cover a transaction, “regardless of its form,” in which goods are delivered to a merchant for the purpose of sale, Revised Article 9 has pulled most true consignments into Article 9. The consignor’s title interest, therefore, is a purchase-money security interest in inventory. This characterization of the consignor’s interest has several effects. First, as a general rule, the consignor’s title interest is subject to the claims of the consignee’s creditors and to purchasers for value from the consignee. The revision accomplishes this result by deeming the consignee “to have rights and title to the goods identical to those that the consignor had or had power to transfer.” This is where you lose your interest in the goods.

However, since Revised Article 9 defines the consignor’s title interest to be a purchase-money security interest in inventory, the usual priority rules apply, and no special consignment priority rules are required. Thus, like any holder of a “security interest,” the consignor can obtain priority over most competing unsecured creditors of the consignee by complying with the Article 9 perfection requirements. For example, the consignor can obtain priority over trustees in bankruptcy and lien creditors,² and over non-ordinary-course buyers and lessees³ simply by filing a financing statement and giving required notices. Because the consignor’s interest is treated as a security interest in inventory, an ordinary course buyer or lessee will take the goods free of any lien interest retained by the consignor.

The filing of the UCC financing statement obtains priority for the consignor over any later-perfected security interest in the consigned inventory. Additionally, the consignor can obtain priority over even an earlier-perfected inventory security interest (and the interest of a bankruptcy trustee) by satisfying the UCC’s purchase-money priority rules. Those rules require that the consignor, before delivering the consigned goods to the consignee, file its financing statement and send an authenticated notification to the holders of conflicting perfected inventory security interests advising them that the consignor has or expects to acquire a purchase-money security interest in the described inventory of the consignee.⁴

In Summary

In summary, for consignments other than a sale-on-approval consignment, a consignor must comply with Revised Article 9’s requirements for obtaining a perfected interest in its goods and protecting its interest from competing secured creditors and lien creditors. That includes executing a proper consignment agreement between the con-signor and consignee, perfecting its consignment interest by filing a UCC-1 financing statement describing the consigned goods in the appropriate filing jurisdiction, and giving appropriate notice to existing holders of liens in inventory. Those steps will afford the consignor priority over a judicial lien creditor, a bankruptcy trustee and subsequent inventory secured creditors.

Judy Thompson is a Partner in the Charlotte office of Poyner & Spruill. She practices in the area of bankruptcy/creditors’ rights. Judy may be reached at 704.342.5299 or jthompson@poynerspruill.com.

¹ In a few states with a sign law, a consignor could also obtain a prior interest in its goods if the consignor complied with the state law that provided notice of the consignment by the consignor’s posting of a sign at the consignee’s place of business. [return]
² See § 9-317(a)(2). As the holder of a “purchase-money security interest,” the consignor also gets the benefit of the 20-day grace period following delivery within which to file its financing statement. See § 9-317(e).
[return]
³ See § 9-315(a)(1) and § 9-317(b) and (c). Note that, unlike prior law, the 20-day grace period now applies to all non-ordinary course buyers and lessees, and not just to buyers in bulk. See § 9-317(e) and cmt. 8 [return]
⁴ See § 9-324(b). The holders of the conflicting interests must receive the notice within five years before the consignee receives possession of the goods. [return]

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This electronic publication is published by Poyner & Spruill LLP to provide general information about significant legal developments. Because the facts in each situation vary, the legal precedents noted herein may not be applicable to individual circumstances.