Consigned Goods – Part II

A costly education.

The crisis in the oil and gas industry has provided considerable work for insolvency attorneys.  Several decisions in a case in the Western District of Washington State just came down and should be of interest to our readers.  One of these cases again addresses the perils that arise when a consignor fails to perfect its interest in goods delivered to a consignee.   In re: Pettit Oil Company began as a Chapter 11 but was subsequently converted to a Chapter 7 and the trustee brought an avoidance action against IPC (USA) Inc., a seller of fuel to Pettit Oil.

The pre-petition debtor and IPC had entered into a consignment agreement whereby IPC delivered fuel to the debtor’s terminals to be sold to its transportation customers.  The consigned fuel was not identified as such but the invoices for consigned fuel sold directed account debtors to make payments to an IPC lockbox.  To complicate matters, in addition to consigning fuel to the debtor it also sold fuel (as did other suppliers) that was not subject to the consigned agreement.   Invoices for non-consigned fuel directed account debtors to make their payments to a lockbox at Key Bank, the debtor’s secured lender.  Any customer might be purchasing both consigned and non-consigned fuel.  As a result customers often paid the Key Bank lockbox when it should have paid the IPC lockbox.  The consignment arrangement continued from the pre-petition period to the post petition period.

When Pettit commenced its Chapter 11 case it sought use of cash collateral.  Although the first interim order granting use of cash collateral did not address the IPC consigned fuel, subsequent interim orders did.  The second interim cash collateral order provided that any “amounts belonging to IPC” be sent to IPC not later than two banking days after deposit in the Key Bank cash collateral account, unless an objection was filed.  The third interim cash collateral order provided that the “amount of the Cash Collateral to be used by Debtor in its operations shall not include any amount in the Cash Collateral Account at KeyBank or in the Third Party Banks consisting of funds belonging to IPC.”  During this period the court also issued a First Supplier Order which authorized the debtor to purchase supplies from certain vendors.  IPC was included as a supplier.

During the three week period immediately following the petition date, there were six transfers from the Debtor’s KeyBank accounts to IPC whereby IPC received over $8 million from the debtor’s fuel sales. Three weeks into the Chapter 11 case, there was in excess of $1 million in inventory in the debtor’s fuel tanks that continued to generate accounts receivable. The accounts receivable generated from this inventory were either (1) paid by customers directly to the IPC Lockbox, (2) paid by customers to the KeyBank Lockbox and remitted to IPC, or (3) paid to the KeyBank Lockbox and retained by KeyBank.  The trustee brought an avoidance action against IPC to recover the post-petition transfers.

The court stated: “Pursuant to § 549, the Trustee may only avoid post-petition transfers of ‘property of the estate.’ IPC argues that the Trustee cannot avoid the post-petition transfers pursuant to § 549 because the sale proceeds of the petroleum products never became property of the estate.  Property of the estate is defined as ‘all legal or equitable interests of the debtor in property as of the commencement of the case.’ [Bankruptcy Code] Section 541(a)(1). The existence and nature of a debtor’s interest in property is determined by non-bankruptcy law.”

The court then focused on UCC §§ 9-102(20) (the definition of Consignment) and 9-319(a) and the impact of IPC’s failure to perfect.  It expressed concerns over IPC’s failure to perfect and whether IPC was a supplier or a consignor that neglected to perfect.  To the extent IPC was a supplier, it would be entitled to be paid for its post-petition sales of fuel.  The concern was how to treat the post-petition payments if IPC was a post-petition unsecured consignor.

“The Trustee does not disagree that title to the fuel inventory remained with IPC post-petition.  It is undisputed that the Consignment Agreement provides that title to inventory and proceeds remains with IPC.  As between the Debtor and IPC, therefore, IPC retained title to and ownership of the inventory and proceeds, even after the Debtor filed bankruptcy, and even though IPC failed to properly perfect its interest.  The Trustee, however, argues that title and ownership are irrelevant to the analysis of whether such inventory, and proceeds that flowed from such inventory, became property of the estate.”

The court did not determine IPC’s fate as an unperfected post-petition consignor and denied the motion for summary judgment:  “The answer may be that the analysis will be the same for property delivered as of the petition date or post-petition by virtue of § 541(a)(7), but neither party has provided sufficient analysis or authority for the Court to render a decision on this issue at this time. The issue in this case may be further complicated by the fact that the product was delivered post-petition pursuant to a prepetition agreement.”

Whether IPC ultimately prevails is inconsequential.  The cost of litigating the issue could have easily been avoided if it had been more knowledgeable concerning the consignments it intended.  As we indicated in our earlier blog, consignments remain a viable method to effect sales but consignors (and their lenders) must assure that the process for perfection is properly followed lest they be subject to a costly education.


The US Supreme Court issued a decision today on a significant case that has been followed by bankruptcy practitioners.  The case relates to whether a judgment for fraudulent conveyance may be discharged.  The Court wrote:

“The Bankruptcy Code prohibits debtors from discharging debts ‘obtained by . . . false pretenses, a false representation, or actual fraud.’ 11 U.S.C. § 523(a)(2)(A).  The Fifth Circuit held that a debt is ‘obtained by . . . actual fraud’ only if the debtor’s fraud involves a false representation to a creditor.  That ruling deepened an existing split among the Circuits over whether ‘actual fraud’ requires a false representation or whether it encompasses other traditional forms of fraud that can be accomplished without a false representation, such as a fraudulent conveyance of property made to evade payment to creditors.  We granted certiorari to resolve that split and now reverse.”

The underlying case involved facts familiar to many lenders.  Daniel Lee Ritz, a director and shareholder of Chrysalis Manufacturing Corp., made transfers to entities in which he had ownership interests draining Chrysalis of assets while it was indebted to Huskey International Electronics, Inc., the plaintiff.  After Husky commenced a lawsuit against him, Ritz filed a Chapter 7.  Husky brought an adversarial proceeding against Ritz claiming the transfers to be “actual fraud” and to bar his discharge.  The District Court held that Ritz was personally liable but that the debt was not “obtained by . . . actual fraud” under § 523(a)(2)A).  The Fifth Circuit Court of Appeals recognized that in transferring Chrysalis’ assets, Ritz may have hindered Husky’s ability to recover its debt, but found that he did not make any false representations to Husky and therefore did not commit “actual fraud.”

The Court noted that the historical meaning of “actual fraud” provides strong evidence that the phrase has long encompassed the kind of conduct alleged to have occurred here:  a transfer scheme designed to hinder the collection of debt.

“‘Actual fraud’ has two parts:  actual and fraud.  The word ‘actual’ has a simple meaning in the context of common-law fraud:  It denotes any fraud that ‘involv[es] moral turpitude or intentional wrong.’ . . . ‘Actual’ fraud stands in contrast to ‘implied’ fraud or fraud ‘in law,’ which describe acts of deception that ‘may exist without the imputation of bad faith or immorality.’ . . . Thus, anything that counts as ‘fraud’ and is done with wrongful intent is ‘actual fraud.'”

Seven of the sitting judges joined in this decision written by Justice Sotomayor with (as you might expect) Justice Thomas as the sole dissenter, writing “The majority today departs from the plain language of § 523(a)(2)(A), as interpreted by our precedents.”

Notwithstanding, the Court held that it must give the phrase “actual fraud” in § 523(a)(2)(A) the meaning it has long held, and interpreted the term “actual fraud” to encompass fraudulent conveyance schemes, even when those schemes do not involve a false representation.

May 16, 2016

Husky Interntional (Actual Fraud) SCOTUS decision

CyberLending 2

My last blog addressed what I like to refer to as CyberLending, a part of what is now generally described as FinTech.  Last week I was featured in an article in the Long Island Business News, the leading business publication on Long Island, New York.  The article is entitled Virtual Lending.  A pdf of that article is attached and the link is:

Yesterday, 60 Minutes presented a feature on FinTech which you can either watch or read here:

Also, last week, the Commercial Finance Association held a seminar in New York City on the Future of FinTech and its planning committee for its annual convention committed to present several panels on FinTech at its November convention.  Whether FinTech (or CyberLending, as I prefer) will dominate the financial world is yet to be seen.  What is clear is that it is getting quite a bit of attention now and cannot be ignored.

I suspect you will be hearing more from me on this topic – but that is enough for today.

CyberLending Has Arrived and Cannot Be Ignored

I just returned from the largest conference dedicated to connecting online lending platforms, investors, and service providers.  Although the majority of the 4000 attendees were involved in consumer lending there was a significant presence of online commercial lenders.  Many of them are involved in small ticket business lending and it was apparent that a minority appear to be acting like prudent lenders while many others will likely have an expensive education.  Either way we must assume that they will ultimately get it right.

Commercial lending is taking place online and will likely continue to grow.  And, yes, there are online lenders reaching well into the lower end of middle market lending with facilities as large as fifty million dollars.

Some online lenders are partnering with traditional brick and mortar lenders such as Chase, Santander, Capital One, Regions, CIT and others.  P2P (peer to peer), marketplace lending and other variations of Cyber-Lending have sufficiently established themselves and traditional commercial lenders need to recognize that change is well underway.

That is not to say that traditional lenders will be replaced by algorithms.  I strongly doubt that can happen but there are platforms that gather, organize and evaluate due diligence information that the commercial lending community should not ignore.

While some of these novice lenders appear to be on the right track many will likely have an expensive education.  Either way we must assume that they will ultimately get it right.

Of course there will be many failures amongst these startups and near startups but there will be a number of survivors who intend to take the food that feeds the children of traditional lenders.  You are not going to beat them so you better join them.

You all have expensive websites to provide information to those shopping for a lender online.  The challenge is how to get comfortable with using the cloud to engage in a dialogue with borrowers.

I do not believe that the personal judgment calls of commercial lenders will be replaced by a computer.  I do believe, however, that the process will be streamlined by cloud data.

My message is that whether or not  you embrace the CyberLenders they will ultimately grow into dominant players in the lending community.  I would rather work with them as I do with traditional lenders and help them become smarter at what we do.

Protecting Rights in Consigned Goods

When Sports Authority filed its Chapter 11 on March 2, 2016, what glared out from the bankruptcy schedules was the extraordinary number of unsecured creditors where the nature of the debt was identified as “consignment and other trade debt.”  It initially appeared that much of the product on Sports Authority’s shelves were consigned goods but that they had not been timely paid, causing their unsecured status.  Not necessarily so.

It turned out that as of the bankruptcy filing, Sports Authority possessed approximately 8.5 million units of consigned goods with an invoice cost to the Debtors of approximately $84 Million.  It appears that many consignment vendors neglected to properly perfect their security interests in the consigned goods by the filing a financing statement and delivering notice to holder or pre-existing liens..

At the onset of the case Sports Authority, relying on consigned goods to keep its stores operating, sought an order authorizing it to continue to sell consigned goods post-petition.  However, they hoped to reserve their rights to challenge the consignment vendors’ interests at a later date.  As a result, consignment vendors fought back.  In the first month of the case, the Debtor brought some 160 adversary complaints challenging the validity of consignment vendors’ claims.

Fortunately for the consignment vendors, Sports Authority needed continued access to consigned goods.  As a result, a quick compromise was reached and submitted to the Court for approval.

All of this could have been easily avoided had the consignment vendors taken simple steps to protect their rights.

Under § 9-102(2), a consignment is a transaction in which a person delivers goods to a merchant for the purpose of sale and the merchant deals in goods of that kind under a name other than the consignor’s.  In addition, the consignor is not generally known by its creditors to be substantially engaged in selling the goods of others.

For a delivery of goods to constitute a true consignment rather than a sale on approval or a sale or return under § 2-326, the consignee will have the same transfer rights and title to the goods that the consignor possessed, notwithstanding the consignee’s otherwise limited interest in the goods.  (§ 9-319(a)).  The consignor must protect its rights to the consigned goods by following the same procedure for perfecting a purchase money security interest in the goods by filing a financing statement pre-delivery.  See § 9-103(d).  Under § 9-317(e), if a consignor files a financing statement with respect to a purchase-money security interest before or within 20 days after the debtor receives delivery of the collateral, the security interest takes priority over the rights of a buyer, lessee, or lien creditor which arise between the time the security interest attaches and the time of filing.  Finally, in order to avoid being subject to a prior lien, the consignor must give written notice to any pre-existing secured creditor having a lien on inventory.

Of course, a buyer in the ordinary course of business takes its property free and clear of all liens, including a properly perfected purchase money security interest held by a consignor.  (§ 9-320(a)).

Following these simple steps will assure that consigned inventory will remain consigned and not become someone else’s collateral.  Lenders to consignors need to monitor their sales to assure that the lender’s interests follow their collateral.