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.