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.