Consignments the Uniform Commercial Code and the Bankruptcy Code Part II

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Jul/Aug 1999

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This article discusses the interaction between consignors and secured creditors under the

Uniform Commercial Code (UCC). UCC §9-114 governs the priority between a consignor and a

creditor with a perfected security interest in a debtor's inventory, and it states:

<blockquote>(1) A person who delivers goods under a consignment which is not a security interest and

who would be required to file under this Article by paragraph (3)(c) of §2-326 has

priority over a secured party who is or becomes a creditor of the consignee and who would

have a perfected security interest in the goods if they were the property of the consignee, and

also has priority with respect to identifiable cash proceeds received on or before delivery of

the goods to a buyer, if

(a) the consignor complies with the filing provision of the Article on Sales with respect

to consignments (Paragraph (3)(c) of §2-326) before the consignee receives

possession of the goods; and

(b) the consignee gives notification in writing to the holder of the security interest if the

holder has filed a financing statement covering the same types of goods before the date of

the filing made by the consignor; and

the consignee receives possession of the goods; and

(d) the notification states that the consignor expects to deliver goods on consignment to

the consignee, describing the goods by item or type.</blockquote>

(2) In the case of a consignment which is not a security interest and in which the

requirements of the preceding subsection have not been met, a person who would have a

perfected security interest in the goods if they were the property of the debtor.<a href="#1" name="1a">1</a></blockquote>

Section 9-114 is intended to protect a creditor with a perfected security interest in a

consignee's inventory, because this provision requires that a consignor provide written

notification to a creditor with a perfected security interest in a consignee's inventory prior to

the consignee receiving the consigned goods. Therefore, §9-114 prevents a secured creditor

from extending further credit based upon the existence of the consigned goods.

Section 9-114 establishes a priority device between a secured creditor and a consignor. Under

§9-114, in order for a consignor to obtain a priority over a creditor with a perfected security

interest in a consignee's inventory, a consignor must comply with the written notification

requirements contained in §9-114(1)(b) and (c). A consignor's failure to comply with the

written notification requirement will result in the consignor's interest in the consigned goods

being subordinated to a creditor with a perfected security interest in the consignee's inventory.

A pertinent case involving the application and the interpretation of §9-114 is Multibank National of Western Massachusetts v. State Street Auto Sales Inc. et al., (State

Street Auto Sales Inc.).<a href="#2" name="2a">2</a> There, the debtor was a used car dealer. The plaintiff, who had a

perfected security interest in the debtor's inventory, sought a declaratory judgment that its

security interest was perfected in automobiles consigned to the debtor. The plaintiff had a floor

plan financing arrangement with the debtor. Defendant Car Barn Inc. had an informal

consignment arrangement with the debtor. Under the consignment arrangement, Car Barn would

retain title to the automobiles until they were sold. If the debtor sold a Car Barn automobile it

would remit the proceeds of the sale to Car Barn after deducting its commission. Car Barn did

not file a financing statement.

The court ruled that the plaintiff's security interest extended to the consigned automobiles, and

that it had priority in the consigned automobiles over the consignors, including Car Barn. The

court stated:

Section 9-114, however, goes further than its professed purpose. It provides that any

consignor who does not comply with the filing provisions of §9-114 has an interest junior

to that of the secured creditor. It thus appears to take priority rights in all consignments

largely out of Article 2 and places them into Article 9, the scope provision of which would

seem to exclude consignments not intended to create security interests. In so doing, §9-114

seems to vitiate much of §2-326, by removing the other ways for the consignor to protect

himself. Furthermore, it grants exclusive rights in the goods to the secured creditor, which

is quite different from the provision in §2-326, which makes the consigned goods subject to

the claims of the consignee's "creditors."<a href="#3" name="3a">3</a></blockquote>

The court interpreted §9-114 to be limited to those instances where the other exceptions

contained in UCC §2-326 were inapplicable. Car Barn failed to prove that it was generally

known that the debtor dealt in consigned goods, and therefore the safe harbor provision contained

in §2-326(3)(b) was inapplicable. In addition, Car Barn failed to file a financing statement

and it could not employ §2-326(3)(c). Finally, Car Barn did not comply with §9-114 because

it failed to provide the plaintiff with written notification of the consignment arrangement.

The analytical approach adopted by the court in Multibank National of Western Massachusetts is

incorrect. Section 2-326(3) is directed at the priorities between a consignor and a general

unsecured creditor. UCC §2-326(3) is bereft of any discussion of the priorities between a

secured creditor and a consignor. Moreover, the priorities between a secured creditor and a

third party are governed by Article 9 because Article 9 governs security interests in personal

property.<a href="#4" name="4a">4</a>

The language of §9-114 is unequivocal; it requires that a consignor provide a secured creditor

with written notification of a proposed consignment. The written notification requirement

furnishes a secured creditor with protection so that it will not be misled or defrauded into

extending credit on the basis of consigned goods. Indeed, §9-114 provides exactly the same type

of protection that a secured creditor receives when another creditor intends to obtain a purchase

money security interest in inventory.<a href="#5" name="5a">5</a>

If the written notification requirement were inconsequential, then §9-114 would be

unnecessary and redundant. Consequently, the only manner in which a consignor with a true

consignment should be able to obtain priority over a creditor with a perfected security interest

in inventory is for the consignor to comply with §9-114.

<hr>

<h3>Footnotes</h3>

<a name="1">1</a> UCC §9-114. <a href="#1a">Return to article</a>

<a name="2">2</a> <a href="http://www.westdoc.com/find/default.asp?rs=CLWP1.1&vr=1.0&cite=… B.R. 215 (Bankr. D. Mass. 1988)</a>. <a href="#2a">Return to article</a>

<a name="3">3</a> Id. at 217. <a href="#3a">Return to article</a>

<a name="4">4</a> UCC §9-102(1). <a href="#4a">Return to article</a>

<a name="5">5</a> UCC §9-312(3). <a href="#5a">Return to article</a>

Journal Authors

Carlos J. Cuevas

Journal Date

Thursday, July 1, 1999 - 12:00