Consignment Rules in Bankruptcy

This can be filed under “more stuff I didn’t know.”  Is inventory the debtor accepted under a consignment agreement property of the estate?  I have had this come up a few times over the years.  A new BAP case has laid out the answer very nicely.   The answer by the way is probably YES!

IPC (USA), Inc. v. Ellis (In re Pettit Oil Company), — B.R. — (9th Cir. BAP October 2017)

Issue:   Are the trustee’s right to proceeds of the sale of consignment goods senior to the consignor?

Holding:   Yes.  Under U.C.C. § 9-319(a), the debtor “is deemed to hold rights and title to the [consigned] goods” as if it owned them outright.  The consignor must comply with “the rules for the creation and perfection of a security interest contained in Article 9.”

Judge Paul Snyder, Western District of Washington

Kurtz, Faris, Brand

Opinion by Frank Kurtz

The creditor here provided gas and fuel to the debtor “on consignment.”  When the case was converted to chapter 7, the trustee claimed that the fuel on hand on the original petition date was property of the debtor under the U.C.C.  The agreement between the debtor and the creditor also provided that when the debtor sold the fuel, it would instruct its customers to pay the creditor directly.  If the customer paid the debtor, the debtor was to immediately forward the proceeds to the creditor.  No UCC-1 was filed.  On the chapter 11 petition date, the debtor was in possession of funds that should have been forwarded to the creditor.  The debtor also had accounts receivable for product of the creditor that it had sold on account but had not yet collected.  The trustee claimed that those were property of the estate also.  The creditor seems to have agreed that the trustee’s rights to the fuel on hand were senior to it but it argued that the cash on hand and the A/R was its property being held by the debtor under a constructive trust.  The bankruptcy court agreed with the trustee and awarded the trustee about $5 million.

The BAP affirmed.  Under U.C.C. § 9-319(a), the debtor “is deemed to hold rights and title to the [consigned] goods” as if it owned them outright.  Under U.C.C. § 9-103(d), the creditor “is deemed to hold only a purchase-money security interest in the consigned goods as against creditors of Debtor consignee.”  The security interest here was not perfected therefore the trustee’s interest is senior to the creditor under section 544(a)(1).  The creditor argued that that applies only to “the goods,” i.e., the gas and fuel – not the cash and A/R, i.e., the proceeds of the sales of the goods.  The BAP disagreed saying:

“[T]he consignor’s retention of title to the collateral may affect the remedies it can employ to recover the collateral in the event of default.  But retention of title does not change the rules concerning priority among competing claimants to the collateral.”

 ”The Official Comment to U.C.C. § 9-114 stated that if a consignor wished to have priority in accounts receivable or other proceeds (cash) generated from the sale of the consigned goods, it had to comply with the rules for the creation and perfection of a security interest contained in Article 9.”

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