Four Steps To Protecting A Proper Consignment
Independent Business AssociationApril 04, 2008
(Published in the IBA Newsletter, April Issue)
As credit tightens and businesses look for opportunities to stretch their working capital and expand into new markets, small businesses are increasingly buying or selling goods on consignment. Under a typical consignment arrangement, goods are held by the buyer for use, improvement or resale, and the seller retains title until the goods are sold or otherwise used. This arrangement allows the buyer to defer payment on the goods until such time as the resale or other use takes place.
In consignment arrangements, sellers take large risks by delivering high volumes of goods to buyers before the goods are purchased. To minimize their risk in the sale, sellers can use the protections offered by the Uniform Commercial Code (UCC), a collection of standardized laws that apply to all commercial transactions, and the guidelines for consignments contained therein.
To protect its interest in the consigned inventory under the UCC, a seller must take the following steps before the consigned inventory is shipped:
1. The seller and buyer enter into a written consignment agreement governing the arrangement. The buyer grants the seller a security interest in the consigned inventory. The arrangement is defined as a true consignment (the seller retains title to the consigned inventory), not a secured sale.
2. The seller files a proper financing statement in accordance with the UCC, naming the seller as secured party and the buyer as debtor, and describing the consigned inventory. 3. The seller sends written notice to all parties with liens on the buyer’s inventory describing the consignment arrangement, the consigned inventory and the date on or after which the consigned inventory is to be delivered to the buyer. A UCC lien search should be performed to determine all such parties.
4. Every five years, the seller files a continuation statement and new notice to all parties with liens in the buyer’s inventory.
If any of these steps are omitted, or if the goods are shipped prematurely, the consequences for the seller can be devastating. A secured creditor of the buyer could claim superior rights in the consigned inventory and any proceeds of the inventory, and a bankruptcy trustee may be able to avoid the consignment entirely. Additionally, if the seller has a lender with a security interest in the seller’s inventory, that lender may now have lost its lien or the priority of its lien in the consigned inventory. Consignments can be a great way to introduce products in new markets and expand customer bases; however, by not complying with the UCC rules governing consignments, sellers take significant risks. Ultimately, they can lose some, if not all of their interests in the consigned inventory and could be left with only unsecured claims against their customers for payment for the inventory.