by Raymond W. Dusch
T
he law of consignment sales of goods, under
which merchandise is delivered by a seller (a
“consignor”) to another person (a “consignee”) to
hold for sale to a third party, has long been a
source of confusion and uncertainty for both consignors
(seeking to protect their rights to their consigned goods)
and creditors of the consignee (seeking to satisfy their
claims against the consignee and its assets). Prior to the
enactment in 2001 of revised Article 9 of the Uniform
Commercial Code, the treatment of consignment sales had
straddled both Article 2 of the UCC, which covers the sale
of goods, and Article 9 of the UCC, which covers the
creation and perfection of a security interest in goods. The
drafters of revised Article 9 sought to eliminate this
confusion by removing all regulation of consignment sales
from UCC Article 2, and lodging all regulation of consignments under the UCC (to the extent not covered by common
law) squarely within UCC Article 9. However, the recent
Bankruptcy Court decision in the case of In re Morgansen’s
Ltd., 302 B.R. 784 (Bankr. E.D.N.Y., October 14, 2003) would,
if sustained on appeal, negate many of the improvements
introduced by revised Article 9 and wreak havoc on the
treatment of consignment sales of consumer goods and
other “true” consignments not expressly covered by
revised Article 9.
Consignments under revised Article 9
A true “consignment” (to the extent governed by, and as defined in, revised Article 9) is
deemed to create a purchase money security interest (PMSI)
in the consigned goods in favor of the consignor (UCC
Sections 9-103(d) and 1-201(37)), so that a consignor who
fails to file a UCC financing statement against the consignee
with respect to the consigned goods risks losing its rights
in the goods to a trustee in bankruptcy or a secured party
having a perfected security interest in the consignee’s
inventory. Although the pre-2001 version of the UCC had
also provided a consignor with a security interest in the
consigned goods, these security interests were not expressly designated as PMSIs (putting in doubt the status of
these interests vis-a-vis holders of prior perfected liens on
inventory), and the rights of the consignee’s creditors in
the consigned goods were covered by both former Section
2-326(3) of the UCC article on sales, as well as by several
sections of UCC Article 9. The drafters of revised Article 9
attempted to rationalize this dichotomy by deleting the
references to consignment sales from former UCC Section 2326(3), and adding new UCC Section 9-102(a)(20) to define
the types of consignments to be covered by UCC Article 9,
as well as new UCC Sections 9-103(d) and 9-319 to specify
JULY/AUGUST 2004
Copyrighted material. For website posting only. Reproduction or bulk printing prohibited.
altogether, the Bankruptcy Court in the case of In re
Morgansen’s Ltd. recently held that Non-Article 9 Consignments (including those made by consumers) should not be
treated as consignments at all, but as outright sales on a
“sale or return” basis under UCC Section 2-326. As a result
of this “pretzel logic,” if a consumer delivers “consumer
goods” (e.g., jewelry, works of art, antiques, etc., “used or
bought primarily for personal, household or family purposes” under UCC Section 9-102(a)(23)) to a known
consignee to hold for sale to a third party (whether or not
the consignee is a merchant or auctioneer), then unless the
consumer (i) enters into an express security agreement with
the consignee with respect to the goods, and (ii) files a UCC
financing statement against the consignee to perfect its
security interest in consigned goods, the consumer will lose
all rights to its property to the consignee’s trustee in
bankruptcy (or other lienholder) if the consignee goes
bankrupt (or grants a voluntary lien on its inventory or has
its property attached by a judgment lien creditor), and will
thus be relegated to the status of an unsecured creditor of
the bankrupt consignee’s estate.
the perfection and priority of these Article 9 Consignments
vis-a-vis trustees in bankruptcy and other competing
security interests.
Under revised UCC Section 9-102(a)(20), a “consignment” (an “Article 9 Consignment”) is defined as a transaction in which: (i) a person delivers goods (other than
“consumer goods” and goods valued at less than $1,000) to
a merchant for the purpose of sale, where the merchant (a)
deals in goods of that kind, (b) is not an auctioneer, and (c)
is not generally known by its creditors to be substantially
engaged in selling goods of others; and (ii) where the
transaction does not expressly create a security interest in
the goods to secure an obligation.
Non-Article 9 Consignments
By removing any mention of Consignments from UCC
Article 2 on sales and then narrowly defining the types of
consignments that would be governed by UCC Article 9,
the drafters of revised Article 9 determined that only certain
(but not all) types of consignments would be governed by
the UCC. Accordingly, if a transaction (i) constitutes a true
Consignment under common law (i.e., in which the title and
risk of loss to the goods are retained by the consignor, until
the goods are sold by the consignee on its behalf), as
opposed to an outright sale of goods (i.e., in which the title
and risk of loss to the goods pass to the purported “consignee,” with the purchase price thereof secured by the
“consigned” goods themselves), and (ii) does not meet the
statutory definition of an Article 9 Consignment under
revised Article 9 (a “Non-Article 9 Consignment”), these
Non-Article 9 Consignments should be governed by law
other than the UCC (usually, the common law of
“bailments” for the purpose of sale) and not by revised
Article 9 or UCC Article 2.
Nevertheless, despite a statutory scheme clearly
designed to protect consumers (and others dealing with
known consignees and auctioneers, etc.) and to remove
Non-Article 9 Consignments from regulation under the UCC
In re Morgansen’s Ltd.
Morgansen’s Ltd. was a dealer in expensive items, such as
jewelry, art, collectibles and furniture. It was located in a small
retail shop in the exclusive community of Southampton, New
York. It sold these items to retail customers, other dealers and
interior decorators in its store and at public auctions.
Approximately 30 percent of these items were purchased
outright by Morgansen’s in estate sales and from walk-in
customers, and the remaining 70 percent were placed with it
“on consignment” by ordinary consumers (who had held
these items for their personal use and enjoyment) and other
dealers (who had acquired and held the items as inventory for
resale). Goods obtained both by direct purchase and by
consignment were commingled in the shop, often in the same
display cases, and were not labeled as being “held for sale on
consignment” or otherwise.
2
Section 2-326(3) in connection with revised Article 9, which
had provided that goods delivered to a person for sale on
consignment were “deemed to be on sale or return” under
that section, unless the person making the delivery (a)
complied with any applicable consignment “sign law,” or (b)
could prove that the consignee was “generally known by
his creditors to be substantially engaged in the selling of
the goods of others,” or (c) duly filed a financing statement
under UCC Article 9 against the consignee with respect to
the consigned goods. However, after noting the deletion of
former sub-section (3), which had been expressly incorporated into the UCC in order to “deem” a true consignment to
be a “sale or return” (and thus subject to the claims of the
consignee’s creditors), the court made a profound logical
leap by deciding to treat all Non-Article 9 Consignments as
“sales or returns” under UCC Section 2-326 (and subject to
the claims of the consignee’s creditors), despite the
absence of the deleted statutory authority and irrespective
of whether these transactions would otherwise be treated as
“sales” under the UCC or common law.
Again, after properly noting that Official Comment No.
1 to UCC Section 2-236, as in effect after the 2001 amendments, provides that “[a] sale or return is a present sale of
goods that may be undone at the buyer’s option,” the court
simply concluded that any Non-Article 9 Consignment must
constitute a “sale or return” under UCC Section 2-236.
However, the court failed to recognize that in order for there
to be a “buyer” in a sale or return transaction under UCC
Section 2-236, a court must first determine that the transaction constitutes a “sale” under the UCC.
Although a consignment and a sale or return may
seem to be the same type transaction — with goods
delivered by Party A to Party B for the purpose of sale to
Party C, and with Party B having the right to return the
goods to Party A for any reason whatsoever — the court
simply ignored that, under common law as embodied by the
UCC, there is a basic difference between a transaction
involving a “sale or return” and a “true” consignment,
which can be summarized as follows:
➤ A “sale or return” is a real sale of delivered goods in
which title to the goods and, unless otherwise agreed
by the parties, the risk of loss to the goods (under
UCC Section 2-327(2)(b)), is initially transferred to a
buyer for ultimate resale to a third party. (Under UCC
Section 2-106(1), a “sale” consists of “the passing of
title from a seller to a buyer for a price.”)
➤ A true consignment is not a real sale but a “bailment”
transaction in which goods are not sold but are
entrusted with another person (much like a coatchecking service or auto-repair garage), but in which
title and the risk of loss to the goods is retained by
the consignor (as the “entrustor” of the goods) until
they are sold to the third-party purchaser. Under a
true consignment, the consignee of the goods bears
the risk of loss merely as a “bailee” (like a coat
Being located in a wealthy summer resort community,
Morgansen’s business was cyclical at best, and its overhead ultimately proved too costly for it to remain in business. On February 20, 2003, Morgansen’s (“Debtor”) filed
for voluntary bankruptcy under Chapter 11 of the Bankruptcy Code and, on August 26, 2003, the case was converted to a Chapter 7 liquidation. The Debtor had significant
unsecured claims from utility companies and other thirdparty suppliers of goods and services. With the Debtor
incurring monthly costs for rent, utilities and insurance in
excess of $10,000, the court ordered the immediate sale of all
the Debtor’s merchandise, including all of its consigned
goods, at a public auction to be held on the Debtor’s
premises, with the net proceeds retained by the Debtor’s
estate to satisfy the claims of its unsecured creditors, which
would include the claims of its consignors, but only as
unsecured creditors of the Debtor’s bankrupt estate.
In its decision, the court expressly noted that,
commingled among the goods that the Debtor had purchased outright in estate sales and from dealers, were
numerous items it had held for sale “on consignment” on
behalf of numerous consumers pursuant to written consignment agreements. In analyzing whether the creditors of the
Debtor’s estate had claims against the consigned goods,
the court correctly noted the new statutory scheme under
revised Article 9:
“The standard approach is first to go to section 9102(a)(20), and if the transaction does not fit under
this section, then to go next to section 2-326; if the
transaction does not fit under section 2-236, then the
transaction falls entirely outside the Uniform Commercial Code, and the Court must then fall back on the
common law of bailments and other traditional
practices.”
However, the court fell far short in applying this
approach.
The court first determined that, for several reasons,
the consignments did not constitute Article 9 Consignments under UCC Section 9-102(a)(20). Although it was
clear that the Debtor was a “merchant,” there was no proof
that the Debtor was “not generally known by its creditors to
be substantially engaged in selling the goods of others,”
and most of the consigned goods constituted “consumer
goods” under the UCC immediately prior to delivery to the
Debtor. The court’s analysis then proceeded to UCC
Section 2-326, as amended in 2001 in connection with
revised Article 9, which provides that: “(1) Unless otherwise
agreed, if delivered goods may be returned by the buyer
even though they conform to the contract, the transaction
is...(b) a ‘sale or return’ if the goods are delivered primarily
for resale,” and that “(2)...goods held on sale or return are
subject to [the claims of the buyer’s creditors] while in the
buyer’s possession.”
The court then noted the deletion of former UCC
3
risk of loss to the goods to the consignee prior to their
resale to a third party. Absent this kind of mutual intent,
there was no authority whatsoever under revised UCC
Articles 2 or 9 for the Morgansen’s court to treat any
Non-Article 9 Consignment as a “sale” to the consignee
or a “sale or return” subject to the rights of the
consignee’s creditors.
The court concluded that, under Debtor’s written
consignment agreements themselves, “the intention of
the parties to these transactions is beyond reasonable
dispute.” The Debtor was authorized to sell the consignors’ goods with an obligation to pay the consignors the
net proceeds of the sale, less its commission. The court
chose to ignore the “form” of the consignment agreement, under which the consignor designated the
consignee as its “exclusive agent” for the purpose of
offering the goods for sale on the consignor’s behalf, at
public auction or otherwise. However, the court fatally
failed to note that these agreements were completely
devoid of evidence of the consignors’ intent to convey
“title” to the goods to the consignee or to anyone else,
other than the ultimate purchasers of the consigned
goods.
The court further ignored express provisions of
those agreements that the consumer-consignors bore
the risk loss (and the risk of insuring the goods against
loss), and that the consignee’s only duty was to
“exercise reasonable care in handling and safeguarding
the property.” The consignment agreements further
evidenced the parties’ intent not to initially pass title to
the Debtor by providing that, if the consigned goods
were not sold by the Debtor and remained in its possession (and were not taken back by the consignor) within
60 days after the “ready pick-up date” for the goods
specified by the Debtor, “title [to the consigned
property] will be deemed to have passed from Consignor to
[the Debtor] and this Agreement shall act as a binding bill
of sale.”
Accordingly, despite the obvious intention of these
parties not to pass title and risk of loss to the goods to the
Debtor, and the clear statutory scheme of revised UCC
Articles 2 and 9 not to regulate consignments that were, by
definition, Non-Article 9 Consignments (which are supposed to be completely outside the scope of the UCC), the
court held that ordinary, unsophisticated consumers, who
are most in need of the protections afforded by the 2001
clarifications and improvements to the UCC (when they
entrust personal items to a consignment store for ultimate
sale to third parties), have no way of protecting their rights
to their personal items under UCC Article 9 or otherwise,
other than to contractually obtain and perfect a PMSI under
UCC Article 9. Thus, in order to be fully protected, the
consumer must (a) at a minimum, enter into a written
security agreement with the consignee and file a financing
statement against the consignee covering the goods, and
checker or repair garage) only to the extent the bailee
is negligent by failing to meet its duty of ordinary
care with respect to the goods (as implied by common
law or as otherwise agreed by the parties).
To understand this crucial distinction, the court
needed to look no further than Official Comment No. 6 to
UCC Section 9-109, which states that (a) Article 9 Consignments “include many but not all ‘true’ consignments (i.e.,
bailments for the purpose of sale),” (b) former UCC Section
2-236(3) had changed the common law result to treat true
consignments as “sales or returns” under the UCC, and (c)
revised Article 9 again changes the common law result, but
“in a different manner” than former Section 2-236(3).
Accordingly, without former Section 2-326(3) in effect to
change the operation of common law and cause a NonArticle 9 Consignment to be treated as a “sale or return,”
consignments such as the Debtor’s should now only be
treated as a “sale or return” if the parties intend, by some
express or implied agreement, to initially transfer title and
4
(b) in many cases, also fulfill the other requirements for
obtaining a perfected, first priority PMSI under UCC Section
9-324 (i.e., before the item is delivered to the consignee, he
or she must (i) file the financing statement against the
consignee, (ii) conduct a UCC financing statement search
against the consignee, and, (iii) send separate notices
directly to anyone with a financing statement on file against
the consignee’s inventory).
In so ruling, the court ignored longstanding commonlaw rules that, absent an intent to sell goods to a “consignee” on a “sale or return” basis, goods that are the
subject of a “true” consignment (and which are not otherwise governed by UCC Article 9) belong to the consignor
until they are sold by the consignee, and are therefore not
subject to the claims of the consignee’s creditors.
Conclusion
To add insult to the consignors’ injury, the court refused to
stay its sale order pending appeal and, on December 4, 2003,
all of the consigned goods were sold at auction, with those
consumers able to afford it bidding on and buying back
their own property. If their appeal is successful, consumers
with winning bids would receive a refund of the purchase
price and be able to retain their prized possessions. However, those consumers that did not bid (or were not successful bidders) will have only the sale price paid by the
buyer at auction to satisfy them. If the decision in the
Morgansen’s case is sustained on appeal, then the drafters
of the UCC may well have to go back to the drawing board
and refine the statute even further to make it crystal clear (to
courts and creditors alike) that property delivered and held
under a Non-Article 9 Consignment is protected by the fact
that the consignee has no interests in or rights to such
property under statutory or common law that can be
reached by their creditors or trustees in bankruptcy. ▲
This article first appeared in the February 2004 issue of
LJN’s Equipment Leasing Newsletter,
and is being republished with its permission.
Raymond W. Dusch is an attorney with
the law firm of Schulte Roth & Zabel
LLP, New York, NY. He is also a
member of the Board of Editors of
LJN’s Equipment Leasing Newsletter,
and a former member of the Legal
Committee of the Equipment Leasing
Association of America.
Reprinted from The Secured Lender, July/August, 2004 by The Reprint Dept., 800-259-0470; Part #9505-1004