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goods that were delivered to a prospective the Wrong Way: purchaser, the . The consignor and consignee are frequently parties to a The Unfortunate Plight of the consignment agreement that contains the terms of the consignment arrangement. The consignee holds the consigned goods Unperfected Consignor for sale or converts the goods to a finished product for sale, and only takes title to the consigned goods when it uses or sells the goods. The consignor frequently issues an containing the payment terms to the consignee after the consignee’s reported sale or use of the goods. The consignee can return unsold or unused goods to the consignor if permitted under the consignment agreement. JULY/AUGUST 2019

THE PUBLICATION FOR CREDIT & FINANCE PROFESSIONALS $9.00 UCC Article 9 governs many consignment transactions. UCC Section 9-102(a)(20) defines a consignment as a transaction A trade creditor seeking to mitigate the in which a person delivers goods to a risk of nonpayment of its claim may opt merchant for purposes of sale, and (a) the to enter into a consignment arrangement merchant deals in goods of that kind under with a distressed customer. A creditor a name other than the name of the person that satisfies all of the requirements for making delivery, is not an auctioneer and consignment contained in Article 9 of the is not generally known by its creditors to be Uniform Commercial Code (“UCC”) obtains substantially engaged in selling the goods Bruce Nathan, Esq., is a partner a first and prior interest in its consigned of others; (b) the goods must have a value in the New York office of the law goods. A creditor that fails to satisfy the of at least $1,000 at the time of delivery; (c) firm of Lowenstein Sandler LLP, UCC’s consignment requirements risks the goods are not consumer goods imme- practices in the firm’s Bankruptcy, Financial Reorganization & Creditors’ forfeiting any prior rights to its consigned diately before delivery; and (d) the trans- Rights Group, and is a recognized goods and being relegated to asserting action does not create a security interest. expert on trade creditors’ rights and a low priority general unsecured claim Whether Sports Authority was not generally the representation of creditors in against its customer. known to be substantially engaged in sell- bankruptcy and other legal matters. ing the goods of others was at issue in the He is a member of NACM, a former The Chapter 11 bankruptcy cases of The Sports Dimension case. member of the board of directors of Sports Authority Holdings, Inc. and its the American Bankruptcy Institute and a former co-chair of ABI’s Unsecured affiliated debtors (collectively, “Sports According to UCC Section 1-201(37), a Trade Creditors Committee. Bruce Authority”) have provided numerous exam- security interest includes a consignment is also the co-chair of the Avoiding ples of how consignment-related disputes subject to UCC Article 9. UCC Section Powers Advisory Committee working ultimately play out when litigated before 9-319(a) also states that a consignee with ABI’s commission to study the a bankruptcy court. Recently, on April 12, acquires all of the consignor’s rights in reform of Chapter 11. He can be 2019, the United States Bankruptcy Court the consigned goods when the consign- reached at [email protected]. for the District of Delaware, in TSA Stores, or’s interest is not perfected. A consignor Michael Papandrea, Esq., Inc. et al. v. Sports Dimension Inc. a/k/a can perfect its interest in its consigned is an associate in Lowenstein Body Glove (“Sports Dimension”), ruled goods by filing a UCC financing state- Sandler’s Bankruptcy, Financial against one of Sports Authority’s trade ment, describing the goods, in the correct Reorganization & Creditors’ Rights vendors that had failed to timely perfect its jurisdiction. A consignor could file a UCC Department focused on providing practical solutions for debtors, consignment interest. The court’s decision on its own, without the consignee’s signa- creditors’ committees, individual illustrates the many hurdles and pitfalls ture, as long as the consignee executes or creditors, and other interested parties facing a non-compliant consignor that fails authenticates a consignment agreement involved in bankruptcy and creditors’ to “dot its i’s and cross its t’s” when selling that describes the consigned goods. The rights matters. Prior to joining goods on consignment. consignor uses the same UCC financing the firm, Mike clerked for multiple statement form that a secured creditor bankruptcy judges in the District of uses in perfecting a security interest in New Jersey and Eastern District of What Is a Consignment? Pennsylvania. He can be reached In a consignment transaction, the seller, personal property collateral. A consignor at [email protected]. known as the consignor, retains title to the that fails to properly file a UCC financing

1 BUSINESS CREDIT JULY/AUGUST 2019 statement risks losing its priority interest in arrangement with the consignor. There is into “pay by scan” consignment agreements the consigned goods to those creditors of a simple rationale for this; Article 9 of the with Sports Authority. Sports Authority had the consignee that obtain a judicial or UCC is supposed to protect creditors from paid its consignment vendors either a fixed security interest in the goods. A bankruptcy “hidden ”—such as the “secret liens” of amount for each item sold or a percentage trustee and debtor-in-possession, as judi- unperfected consignors. If a secured lender of its retail sales price of goods sold. cial lien creditors, would also enjoy priority knows about a particular consignment over an unperfected consignor. arrangement when it had made its loan In 2011, Sports Dimension had entered into to the debtor, then the unperfected con- a pay by scan consignment agreement A consignor must do more than merely signor’s interest is no secret to the lender, with Sports Authority while BOA was the file a UCC financing statement to obtain and the unperfected consignor would not agent under the term loan. However, Sports a superior interest in its consigned goods. run afoul of the notice requirements of Dimension did not file a UCC-1 financing UCC Section 9-103(d) states that a con- UCC Article 9 in claiming priority over the statement covering its consigned goods signor has a purchase money security secured lender’s perfected blanket security until January 25, 2016, approximately one interest in its consigned goods. As such, interest in the consignee’s inventory. month before the Petition Date. Despite a consignor has priority over a creditor WSFS having succeeded BOA as the term with prior blanket security interest in the However, proving the existence of a true lenders’ agent prior to Sports Dimension’s consignee’s inventory if the consignor sat- consignment is no easy task. The Sports UCC-1 filing and WSFS having previously isfies all of the following requirements for Dimension case serves as a painful filed a UCC-1 financing statement, Sports a valid purchase money security interest reminder that a consignor risks losing pri- Dimension failed to provide notice of its contained in UCC Section 9-324: (a) per- ority status with respect to its consigned consignment to WSFS, as required by fection of the consignment interest prior to goods unless the consignor satisfies the UCC Article 9. the consignee’s possession of the goods; UCC’s requirements for . (b) delivery of a notice to the holders of Early in the Chapter 11 case, the consign- conflicting security interests in the consign- The Facts of the Sports ors had disputed Sports Authority’s right ee’s inventory stating that the consignor Dimension Case to pledge or sell their consigned goods. has, or expects to, acquire a consignment On March 2, 2016, (the “Petition Date”), The bankruptcy court approved Sports interest in the goods and describing the Sports Authority, a national retailer of Authority’s sale of consigned goods in goods; and (c) of the notice by the sporting goods and active apparel, filed its the ordinary course of business as long holders of conflicting security interests in Chapter 11 cases in the bankruptcy court as Sports Authority had complied with its the goods. in Delaware. Prior to the Petition Date, in pre-petition consignment agreements. The 2006, Sports Authority had entered into order preserved WSFS’ right to recoup pay- If a consignment transaction fails to meet a secured lending facility that included a ments that Sports Authority had made to the rigid definition of a consignment under term loan, which, following a refinancing, the consignors from the sale of consigned UCC Section 9-102(a)(20), the consignor had an outstanding principal balance of goods in the event the court later ruled may still enjoy prior rights to its consigned $300 million. Bank of America (“BOA”) was that WSFS had a superior interest in the goods if it can prove that the transaction is the administrative agent for the term loan consigned goods. a “true consignment” under state law. True lenders. The term loan, which was at issue consignments are not governed by UCC in the Sports Dimension case, was secured On March 16, 2016, Sports Authority com- Article 9; therefore, true consignments by, among other assets, a second priority menced an adversary proceeding against do not require a consignor to file a UCC security interest in Sports Authority’s inven- Sports Dimension, seeking a declaratory financing statement and provide notice of tory. The term loan security interest was judgment regarding the priority of Sports its consignment interest to secured credi- created by Sports Authority’s execution of Dimension’s interest in its consigned tors with a prior perfected blanket security a security agreement that included Sports goods. WSFS intervened as a plaintiff in interest in the consignee’s inventory as a Authority’s inventory as collateral, and was the adversary proceeding and sought (1) condition for having priority status in the perfected by the filing of UCC-1 financing a declaration that WSFS’ (and the term consigned goods. statements in the necessary jurisdictions. In lenders’) perfected security interest in December 2015, Wilmington Savings Fund Sports Dimension’s consigned goods was Courts, including the Delaware bankruptcy Society (“WSFS”) replaced BOA as the senior to Sports Dimension’s unperfected court, have held that a true consignment term lenders’ agent. On the Petition Date, consignment interest and (2) disgorgement exists where the consignor proves that WSFS asserted a secured claim against of all payments that Sports Dimension had (1) the consignee’s creditors generally Sports Authority for the remaining balance received from Sports Authority’s sale of the knew that the consignor was substan- of the term loan in the principal amount of consigned goods. Sports Dimension filed tially engaged in selling the goods of third approximately $276.7 million. an answer and counterclaim, seeking a parties, such as consigned goods, or (2) declaration that WSFS’ security interest did the consignee’s secured lender or other As part of its business, Sports Authority had not attach to Sports Dimension’s consigned secured creditor had actual knowledge developed a program for vendors to sell goods and that WSFS’ lien was subordinate that the consignee had a consignment goods on consignment terms by entering to Sports Dimension’s consignment interest.

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On September 10, 2018, the parties filed engagement” in selling the goods of others of the consignee’s consigned goods falls cross-motions for summary judgment is met only if consigned goods comprise below the 20% threshold upheld by the regarding their respective interests in 20% or more of the value of a debtor’s Delaware bankruptcy court. the consigned goods and their proceeds. inventory. Since it was undisputed that less WSFS argued that the consignment was than 20% of Sports Authority’s inventory Indeed, in the March 2019 edition of subject to UCC Article 9. As such, and was comprised of consigned goods, the Business Credit magazine, we discussed under UCC Article 9, WSFS’ and the term court concluded Sports Dimension had another recent decision in the Sports lenders’ interest in the consigned goods failed to prove that Sports Authority’s cred- Authority bankruptcy cases involving a dif- was superior to Sports Dimension’s con- itors generally knew Sports Authority was ferent unperfected consignor, Performance signment interest because WSFS had “substantially engaged” in selling the goods Apparel Corp. (“PAC”). The court had upheld filed its UCC-1 financing statement before of others. The bankruptcy court also held PAC’s prior rights to its consigned goods Sports Dimension filed its financing state- that Sports Dimension did not prove that where PAC had proved that BOA and the ment, and Sports Dimension had failed to either WSFS or the term lenders had actual secured term lenders were aware of PAC’s provide notice of its consignment interest to knowledge of Sports Dimension’s consign- consignment arrangement when the term WSFS as required to obtain a prior interest ment arrangement with Sports Authority. loans were made to Sports Authority. As in the consigned goods. a result, the court characterized PAC’s Having determined that UCC Article 9 arrangement with Sports Authority as a true Sports Dimension argued that UCC Article governed Sports Dimension’s consign- consignment that was not governed by UCC 9 does not govern the priority of WSFS’ (and ment arrangement, the court then rejected Article 9. However, as we had previously the term lenders’) and Sports Dimension’s Sports Dimension’s contention that it had pointed out, the lenders’ term loan agree- interests in the consigned goods because satisfied UCC Article 9’s requirement to ment explicitly referenced PAC’s consign- the consignment arrangement was a “true send a notification of the consignment to ment interest and PAC had a UCC financing consignment”. Sports Dimension con- all secured parties with a blanket security statement describing its consigned goods tended that (1) Sports Authority’s creditors interest in all of Sports Authority’s inventory. on file when the term loan was extended generally knew Sports Authority was sub- Quite simply, Sports Dimension messed up to Sports Authority. Without such clear-cut stantially engaged in selling the goods of when it had failed to send notice of its con- facts, it would have been very challenging others and (2) WSFS was actually aware signment interest to WSFS, and had instead for PAC to prove a true consignment. of Sports Authority’s consignment arrange- sent notice to the term lenders’ predecessor ment with Sports Dimension. Alternatively, agent, BOA. WSFS had filed a UCC-1 financ- It is critical that a prospective consignor Sports Dimension argued that even if ing statement prior to Sports Dimension’s familiarize itself with its consignee’s busi- the UCC had governed the consignment, UCC filing and, therefore, Sports Dimension ness and relationships with other secured Sports Dimension had satisfied the UCC’s was required to provide WSFS, and not the creditors to determine whether the UCC notice requirements by sending notice of its predecessor agent, BOA, notice of Sports applies by determining what portion of the UCC filing to BOA prior to the Petition Date. Dimension’s consignment interest in order consignee’s business relates to consigned to enjoy priority over WSFS and the term goods and whether other secured creditors The Court’s Granting of Summary lenders. The bankruptcy court found no are aware of the prospective consignment Judgment in WSFS’ Favor authority for excusing Sports Dimension arrangement. Further, if the UCC applies, The bankruptcy court rejected each of from giving notice of its consignment inter- best practices require that a consignor Sports Dimension’s arguments. Sports est to WSFS, particularly where there was not only file a UCC-1 financing statement Dimension could not prove the existence of no evidence that BOA had forwarded Sports as soon as possible, but also conduct a a true consignment arrangement that would Dimension’s notice to WSFS. UCC search and give notice to any other have excused Sports Dimension from filing creditors that have filed UCC-1 financing a UCC financing statement and complying Conclusion statements covering all of the consignee’s with UCC Article 9’s notice requirements. Though Sports Dimension has filed an inventory. Failure to conduct this due dil- appeal, which remains pending, the Sports igence and provide requisite notice can The court concluded that Sports Authority Dimension case highlights the importance prove quite costly where the consignor is was not “substantially engaged” in con- of following the applicable requirements tasked with defending the priority of its signment transactions. WSFS and Sports for perfection and priority under UCC consignment interest. Dimension stipulated that at no point in Article 9. Litigating whether a consignment their business relationship did consigned arrangement is governed by UCC Article *This is reprinted from Business Credit goods comprise more than 14% of Sports 9’s requirements is costly and potentially magazine, a publication of the National Authority’s inventory. Further, as the court an uphill battle. Proving a secured credi- Association of Credit Management. This noted, the term loan documents included tor’s knowledge of a consignor’s specific article may not be forwarded electronically a statement that consigned goods were consignment arrangement is very difficult. or reproduced in any way without written an immaterial portion of Sports Authority’s Likewise, proving a consignee is substan- permission from the Editor of Business total inventory for sale. The court ultimately tially engaged in selling consigned goods Credit magazine. held that the threshold for “substantial may be a factual impossibility if the value

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