Consigned to Confusion Consignments Under Revised Article 9

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Dec/Jan 2001

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Editor's Note:

This is the final column in a series of 20 Journal columns, written
by Prof. Warner, that explore the changes in secured transactions law and bankruptcy
law that may result from the revision of Article 9 of the UCC. Beginning in
2002, the Lien on Me column will no longer be limited to issues involving the
Article 9 revision, but will include the whole range of secured transaction issues
and will feature a number of different authors, many from ABI's UCC Committee.
ABI members wishing to contribute future Lien on Me articles should contact
<a href="mailto:ckanon@abiworld.org">ckanon@abiworld.org</a>.

</blockquote>

The Article 9 revision radically changes the way the Uniform Commercial Code
addresses consignments by moving the treatment of most such transactions from Article
2 into Article 9. While this change will greatly alter the legal analysis of
consignment questions, the revision will have little practical effect in most cases.
The primary effect of the revision is to bring most consignments into Article 9 and
to treat them like purchase-money security interests in inventory. This is similar to
the treatment of consignments under prior law.

While the revision clarifies a number of minor points that arose under prior law,
it also creates some new areas of uncertainty. Part of that uncertainty arises from
the subtle nature of the drafting choices. One must read the statute very carefully
in order to work out the rules, and this author believes that both courts and
practitioners may have difficulty reaching correct conclusions.

<h3>Consignments and Security Interests</h3>

A classic consignment is a transaction where the owner of goods delivers possession
to a bailee who is also given the power to sell the goods to its customers. Title
remains with the consignor until the goods are sold to the ultimate buyer and the
consignee is free to return any unsold goods to the consignor. Under prior law, a
purported "consignment" transaction might actually be a disguised "security interest."
For example, if the purported consignee was not free to return unsold items but was
required to purchase them, the transaction would be recharacterized as a secured
sale—with the purported title that was retained by the consignor being limited in effect
to a security interest. This recharacterization subjected the transaction to all of the
usual Article 9 rules.

While the changes made by the revision reduce the importance of the consignment/security interest distinction, it is still the first step in the analysis. Under
revised Article 9, all such "security consignments" are covered by Article 9
and treated as ordinary security interests.<a href="#2" name="2a">2</a> While this means that the purported
consignor must perfect its interest in order to establish priority, the primary
significance of the recharacterization is that the purported consignor cannot merely
recover the consigned goods upon the consignee's default. Instead, the purported
consignor must comply with the Article 9 repossession and sale rules. Thus, unless
the purported consignee consents to a strict foreclosure, the purported consignor must
conduct a UCC sale of the goods and account to the consignee if the sale produces
a surplus.

<h3>True Consignments and "Sale or Return" Transactions</h3>

In addition, a distinction must be made between a "true-consignment" and a
"sale-or-return" transaction. The two types of transactions are very similar in that
in both cases the buyer/consignee is free to return the goods even though they conform
to the contract. In a true consignment, the consignor transfers possession to the
consignee, but retains title. However, in a sale-or-return transaction, title is
transferred to the buyer upon delivery, but the buyer has a contractual right to
return the goods.<a href="#3" name="3a">3</a> The conceptual distinction between the two is that a
sale-or-return transaction is a present sale and the recipient of the goods is a
"buyer," whereas there is neither a present sale nor a buyer in a true consignment.
It is this technical conceptual distinction that caused the drafters to decide that
consignments should be removed from Article 2—because Article 2 should deal only with
the "sale" of goods.

Under the former law, both sale-or-return transactions and most true consignments
were dealt with under §2-326 of Article 2 of the UCC. Under that section,
goods held on sale-or-return were subject to the claims of the buyer's creditors while
in the buyer's possession.<a href="#4" name="4a">4</a> Although true consignments were not technically
sale-or-return transactions, former §2-326(3) provided that goods on consignment
generally were deemed to be on sale-or-return if they were delivered for sale to a
person who maintained a place of business at which he dealt with goods of that kind
under a name different from the name of the consignor. The effect of this provision
was to subordinate the title interest of the true consignor to inventory secured
lenders, trustees in bankruptcy, lien creditors and even the general creditors of the
consignee.

There were three ways in which the true consignor could avoid the effect of that
section and preserve its priority with respect to the consigned goods. First, the
section did not apply if the cosignor complied with an applicable sign law—although
there apparently were no such laws. Second, the section did not apply if the
consignee was "generally known by his creditors to be substantially engaged in selling
the goods of others." However, this test was imprecise and was very hard to meet
in most cases. The final method by which a consignor could protect its interest was
by complying with the filing provisions of Article 9.

Former Article 9 accommodated §2-326 by permitting consignors to file protective
"consignment" financing statements under former §9-408 and by subjecting them to
priority rules almost identical to the rules that applied to purchase-money security
interests in inventory.<a href="#5" name="5a">5</a> Since the only safe practice for consignors of inventory was
to comply with the Article 9 filing requirements, this brought most consignments
into former Article 9's filing and priority provisions as a practical matter.

<h3>Article 9 Applies to Most True Consignments</h3>

The revision amends former §2-326 to delete all references to consignments.<a href="#6" name="6a">6</a>

Thus, consignments are no longer subject to Article 2, and its rule that goods on
sale-or-return are subject to the claims of creditors no longer applies to them.<a href="#7" name="7a">7</a>
Instead, the scope of Article 9 has been expanded to apply to "consignments,"<a href="#8" name="8a">8</a>
a term that is broadly defined to cover a transaction, "regardless of its form," in
which goods are delivered to a merchant for the purpose of sale.<a href="#9" name="9a">9</a>

Despite the breadth of the general "consignment" definition, Article 9 expressly
excludes from that definition five different classes of transactions that might otherwise
be covered.<a href="#10" name="10a">10</a> First, consignments are excluded from the Article 9 definition if
the merchant (1) conducts its business under the same name as the consignor, (2)
is an auctioneer, or (3) is "generally known by its creditors to be substantially
engaged in selling the goods of others."<a href="#11" name="11a">11</a> These exclusions largely carry forward the
limitations that were either explicit or implicit in former §2-326(3). In
addition, the Article 9 definition also excludes consignments where the goods were
consumer goods immediately before delivery.<a href="#12" name="12a">12</a> This provision will exclude the situation
where a consumer consigns used items to a resale shop. Finally, the revision excludes
low value consignments where, "with respect to each delivery, the aggregate value of
the goods" is less than $1,000 at the time of delivery.<a href="#13" name="13a">13</a>

These "orphan consignments" are not covered by either revised Article 9 or revised
§2-326. Ironically, although the general thrust of the Article 9 revision has
been to provide explicit statutory answers to most questions, it takes the opposite
approach with respect to "orphan consignments"—leaving their treatment to non-Code common
law. Presumably, the non-Code law gives priority to the title retained by the true
consignor;<a href="#14" name="14a">14</a> however, the consignor might have preferred the certainty provided by an
express Code answer.

This issue may be important in some businesses such as the jewelry business, where
consignments are common. If the jeweler is "generally known by its creditors to be
substantially engaged in selling the goods of others," then Article 9 does not apply
and the consignor's rights against competing creditors turn on non-Code law. Further,
the consignor gains no rights by filing a financing statement or otherwise complying
with the Article 9 rules. If, on the other hand, the jeweler does not meet the
"generally known" test, then the consignor's priority depends on its compliance with
Article 9. The "generally known" test is vague and does not yield predictable
results. For example, although sophisticated lenders and other jewelers may know that
a jeweler is substantially engaged in selling the goods of others, that may not
satisfy the "generally known" standard if the landlord, phone company, electric company
and other creditors do not have that knowledge.

<h3>Priority of True Consignments</h3>

Having pulled most true consignments into Article 9, the revision then defines
the consignor's title interest to be a purchase-money security interest<a href="#15" name="15a">15</a> in
inventory.<a href="#16" name="16a">16</a> This characterization of the consignor's interest has several effects.
First, as a general rule, the consignor's title interest is subject to the claims
of the creditors of, and purchasers for, value from the consignee. The revision
accomplishes this result by deeming the consignee "to have rights and title to the
goods identical to those that the consignor had or had power to transfer."<a href="#17" name="17a">17</a>

However, since the revision defines the consignor's title interest to be a
purchase-money security interest in inventory, the usual Article 9 priority rules
apply, and no special consignment priority rules are required.<a href="#18" name="18a">18</a> Thus, like any
holder of a "security interest," the consignor can obtain priority over most competing
claimants by complying with the Article 9 perfection requirements.

For example, the consignor can obtain priority over trustees in bankruptcy and
lien creditors,<a href="#19" name="19a">19</a> and over non-ordinary course buyers and lessees<a href="#20" name="20a">20</a> simply by
filing a financing statement. However, since the consignor's interest is treated as
a security interest in inventory, it will be subordinate to the rights of an
ordinary course buyer or lessee even if it files a financing statement.<a href="#21" name="21a">21</a>

Similarly, by filing or otherwise perfecting its interest, the consignor can obtain
priority over any later-perfected security interest in the consigned inventory.<a href="#22" name="22a">22</a> In
addition, like any other purchase-money security interest in inventory, the consignor
can obtain priority over even an earlier-perfected inventory security interest if it
satisfies the purchase-money priority rules. Those rules require that the consignor,
before delivering the consigned goods to the consignee, must file its financing
statement and send an authenticated notification to the holders of conflicting perfected
inventory security interests advising them that it has or expects to acquire a
purchase-money security interest in the described inventory of the consignee.<a href="#23" name="23a">23</a>

Note that the new Article 9 filing rules may make it both easier and harder to
comply with the filing and notice requirements. Since the inventory filings must now
be made in the state of the debtor's location rather than the location of the goods,
a single financing statement filed in a single state will perfect consigned goods
located at stores throughout the nation.<a href="#24" name="24a">24</a> However, since virtually all filings
relating to the debtor will be concentrated in a single filing office, and since
super-generic "all-assets" descriptions are now permitted, a search for inventory-related
filings may produce a large number of creditors who must be notified, even though many
may in fact claim no interest in the particular consigned inventory.<a href="#25" name="25a">25</a>

<h3>Enforcement of True Consignments</h3>

Although Article 9 defines true consignments as purchase-money security interests,
it does not subject them to the Article 9 repossession and sale rules. While a
"security consignment" would be subject to the usual Article 9 enforcement provisions,
§9-601(g) provides that those provisions impose "no duties upon a secured party
that is a consignor." As a result, a true consignor is free to enforce its title
interest under applicable non-Code consignment law, without regard to the duties
normally imposed on Article 9 secured parties.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> The views expressed herein are Prof. Warner's and do not necessarily reflect the views of the University of Missouri or the law
firm of Greenberg Traurig P.C. Special thanks to Prof. William Henning and the participants of the UCC Law listserve for explaining (and
disagreeing about) the effects of the revision. The listserve commentators whose discussion piqued my interest in consignments and helped form
my conclusions include Prof. Steven Harris, Randy Perlmutter, Prof. Allan Axelrod, Don Rapson, Prof. Paul Shupack and Prof. William
Vukowich. <a href="#1a">Return to article</a>

<a name="2">2</a> See §9-109(a)(1), cmt. 6 (covering a transaction, "regardless of form," that has the effect of creating a security
interest); §9-102, cmt. 14; see, also, §1-201(37) (defining "security interest"); compare §9-102(a)(20)(D)
(addressing consignments that create security interests). All citations are to the revised 1999 version of Article 9 of the Uniform
Commercial Code (and the related conforming amendments to Articles 1 and 2) unless otherwise indicated. Citations to the prior version
of Article 9 are indicated by the term "former." <a href="#2a">Return to article</a>

<a name="3">3</a> This type of transaction is a sale-or-return transaction if the goods are delivered to the buyer primarily for resale.
§2-236(1)(b). If the goods are delivered to the buyer primarily for use by the buyer, but the buyer has the right to return them,
the transaction is a "sale on approval." §2-236(1)(a). An example of a "sale on approval" would be a 30-day no risk trial. <a href="#3a">Return to article</a>

<a name="4">4</a> See former §2-326(2). This provision is retained by the revision. <a href="#4a">Return to article</a>

<a name="5">5</a> Compare former §9-114 (consignments) with former §9-312(3) (purchase-money security interests in inventory). <a href="#5a">Return to article</a>

<a name="6">6</a> See §2-326. <a href="#6a">Return to article</a>

<a name="7">7</a> This change may cause confusion for two reasons. First, many attorneys are used to thinking of consignments as sale-or-return
transactions. Second, the correct reading of revised §2-326 requires that great emphasis be placed on its use of the term "buyer," and
a casual reader may not realize that the term excludes a consignee. <a href="#7a">Return to article</a>

<a name="8">8</a> See §9-109(a)(4). <a href="#8a">Return to article</a>

<a name="9">9</a> See §9-102(a)(20). Since this definition makes no reference to title retention, it appears to be broad enough to include
a sale-or-return transaction. However, comment 6 to §9-109 states, without explanation, that a sale-or-return transaction is not
included in the consignment definition. See §9-109, cmt. 6. <a href="#9a">Return to article</a>

<a name="10">10</a> Of course, if the purported consignment is a disguised security interest, Article 9 will cover it even if it falls into one
of these categories. See §9-102(a)(20)(D). <a href="#10a">Return to article</a>

<a name="11">11</a> §9-102(a)(20)(A). <a href="#11a">Return to article</a>

<a name="12">12</a> §9-102(a)(20)(C). <a href="#12a">Return to article</a>

<a name="13">13</a> §9-102(a)(20)(B). This exception could surprise a perfected inventory secured lender since the aggregate effect of numerous
small deliveries could be substantial. However, the value limitation may be too low to protect artists who place their works in galleries
on consignment. Nonetheless, several states have non-UCC laws that override the UCC and protect consigned artistic works. See, e.g.,

N.Y. Arts & Cult. Aff. Law §1201 (McKinney 2001). <a href="#13a">Return to article</a>

<a name="14">14</a> See §9-109, cmt. 6. Arguably, the §2-403(1) "derivative title" rule may yield that result; however, its application
is uncertain because Article 2 no longer applies to true consignments. Note that the derivative title concept would give an "orphan consignment"
priority over a perfected inventory security interest, even though the consignor did not file a financing statement or give notice to the prior
perfected inventory lender. <a href="#14a">Return to article</a>

<a name="15">15</a> Revised §1-201(37) defines the term "security interest" to include "any interest of a consignor...that is subject to Article
9." <a href="#15a">Return to article</a>

<a name="16">16</a> Section 9-103(d) provides, "The security interest of a consignor in goods that are the subject of a consignment is a
purchase-money security interest in inventory." <a href="#16a">Return to article</a>

<a name="17">17</a> See §9-319(a). <a href="#17a">Return to article</a>

<a name="18">18</a> See §9-319, cmt. 2. Note that §9-319(b) appears to defer to non-Code law to determine the rights of the consignor
in those cases where it has priority over the competing creditor. The comments to §9-319 make clear that subsection (a) deals with the
situation where the consignment is unperfected, and subsection (b) deals with the situation where the consignment is perfected and has priority
over the competing creditor. Unfortunately, the statutory language is not so clear. Subsection 9-319(b) uses the terminology "if...a
perfected security interest held by the consignor would have priority." This suggests a "hypothetical" test, rather than the "actual" test
reflected in the comments, and may give rise to confusion. <a href="#18a">Return to article</a>

<a name="19">19</a> See §9-317(a)(2). As the holder of a "purchase-money security interest," the consignor also gets the benefit of the
20-day grace period following delivery within which to file its financing statement. See §9-317(e). <a href="#19a">Return to article</a>

<a name="20">20</a> See §9-315(a)(1) and §9-317(b) and (c). Note that, unlike prior law, the 20-day grace period now applies to
all non-ordinary course buyers and lessees, and not just to buyers in bulk. See §9-317(e) and cmt. 8. <a href="#20a">Return to article</a>

<a name="21">21</a> See §9-320(a) (ordinary course buyer) and §9-321(c) (ordinary course lessee). <a href="#21a">Return to article</a>

<a name="22">22</a> See §9-322(a)(1) ("first to file or perfect" priority rule). <a href="#22a">Return to article</a>

<a name="23">23</a> See §9-324(b). The holders of the conflicting interests must receive the notice within five years before the consignee receives
possession of the goods. <a href="#23a">Return to article</a>

<a name="24">24</a> See, generally, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, G. Ray, "Secured Transactions: New Filing Rules Follow the Debtor," 19 Am. Bankr. Inst. J.
16 (March 2000)</a>. <a href="#24a">Return to article</a>

<a name="25">25</a> See, generally, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, G. Ray, "Secured Transactions: Documenting a Transaction Under Revised Article 9," 19 Am. Bankr.
Inst. J. 20 (April 2000)</a>. <a href="#25a">Return to article</a>

<hr>

</td>

Journal Authors

G. Ray Warner

Journal Date

Saturday, December 1, 2001 - 12:00

Bankruptcy Rule

2001