Consignment Arrangements: Dos & Don’ts to Avoid Getting Hurt

What Happens When Your Consignee Becomes Distressed and What You Can Do

I was speaking with a client yesterday about consignment arrangements. What we discussed should be of interest to any company that sells goods using a consignment arrangement, and I thought I would share.

What is a Consignment Arrangement?

In a consignment arrangement, the consignor, as owner of the goods, delivers them to a consignee.  The consignee, in turn, will try to sell those goods to customers.

Be Careful Not to Mischaracterize the Proceeds You Expect from a Consignment Arrangement as Accounts Receivable

The consignor acquires a right to payment from the consignee only when the consignee sells them to its customers. Unsold goods simply get returned to the consignor. This is mentioned in a very good article co-authored by my friend Michael Schwarzmann and his colleague David Gottlieb, “Finding Truth in a Debtor’s Balance Sheet: Analyzing Assets, Liabilities and Equity.”

You Probably Have More Collection Risk than You Realize

If your consignment agreement is documented and executed correctly, it can protect you in the event your consignee becomes insolvent (i.e., if its secured lender forecloses on its collateral—which, if you don’t do a consignment correctly, will include your goods), if it files bankruptcy, or in certain other circumstances. My terrific bankruptcy lawyer-friend in Los Angeles discussed this in a two-and-a half minute clip.

More In-Depth Information from Westlaw

Paraphrasing §16A:18 of Commercial Bankruptcy Litigation¹:

“Consignments” are defined under UCC Article 9 in UCC §9-102(20), and are treated under UCC §1-201(35) as a security interest arrangement, with the consignor as secured party, whether or not intended as a secured transaction.

Consignments arise where (i) goods are delivered to a merchant for the purpose of sale, have a value over $1,000 for each delivery, are not consumer goods in the hands of the person making delivery, and (ii) the merchant deals in goods of that kind under its own name, is not an auctioneer, and is not generally known to sell the goods of others.

Accordingly, for a consignor to protect its “security interest” from competing claims of the consignee’s creditors and from avoidance actions under section 544(a)(1) of the Bankruptcy Code, a consignor must perfect its interest by filing a financing statement like any other security interest.

Unperfected security interests of consignors in goods in a chapter 11 debtor’s possession that are delivered prepetition can be avoided under strong-arm powers based on the debtor-in-possession’s status as the hypothetical lien creditor.

---

[Editor’s Note: If this article is helpful, consider subscribing to Opportunity Amidst Crisis, A tour guide for business owners & investors, of the offensive & defensive use of business bankruptcy & its alternatives. You may also want to download a free PowerPoint that was used in the Opportunity Amidst Crisis Webinar.

You may also benefit from the webinar, What to Expect and Do When Your Customer Becomes Insolvent.

Author’s Note: As the disclaimer on the DailyDAC website states, you should not make any decisions based on this article, other than the decision to consult with your attorney. While I am an attorney (and a darn good one at that), I am not your attorney (though I could be). Also, every situation is different and even a small change in the facts can lead to a very different result.]

Footnotes: 

1. This chapter of Commercial Bankruptcy Litigation is authored by Etahn Cohen of the Sugar Firm (Sugar Felsenthal, et al.- which is my firm) and Louis Chiappetta of Mayer Brown. I am the book’s editor-in-chief and principal author. The text above is included here with the permission of the publisher, Thomson Reuters.

©All Rights Reserved. November, 2020.  DailyDAC^TM, LLC