Treatment of Consignment Inventory in Bankruptcy

February 2012

In a consignment agreement, the vendor (the consignor of the goods) delivers the consigned goods to the retailer (the consignee) to be sold.  Typically, the retailer does not have to pay the vendor for these goods until they are sold to the retailer’s customers.  As such, the vendor retains title to the consigned goods until they are sold.  The retention of title to the consigned goods provides a degree of protection to the vendor that wants to ship goods to a financially troubled retailer.

If the vendor follows the proper steps, it will be in the position, if it chooses, to take back its goods from the retailer upon a bankruptcy filing.  In recent years, as more retailers have faced financial difficulties, more consignment arrangements have been utilized by vendors.  However, consignors must file the proper paperwork to perfect their interest in the consigned goods and give notice about the consignment arrangement to third parties.  If the consignor fails to properly perfect its interests in the consigned inventory, it may result in the vendor being treated as a general unsecured creditor.  The goods will be sold off and the proceeds distributed to satisfy administrative, secured and priority claims before being distributed pro-rata to all general unsecured creditors.

What does the vendor have to do to perfect its interest in consigned goods?  There are three steps that a consignor should take:
  1. File a financing statement describing the inventory in the appropriate place.
  2. Send an authenticated notification to the retailer of the security interest.
  3. Ensure that the notification describes the goods and states that the supplier has or expects to acquire a security interest in inventory of the retailer.
The vendor must understand that an unperfected consignment is nothing more than a sale on open account.  In other words, an unperfected consignment means that the vendor has lost its hold on its goods and if the retailer fails to make payment, the consignor may not be able to reclaim the consigned goods.

In conclusion, it is possible to avoid dealing with the potential inability to get back consigned goods delivered to a retailer that subsequently files for bankruptcy. Before shipping the goods to the retailer, the consignor should (a) ensure the language is properly drafted in the consignment agreement, and (b) properly and timely file a financing statement.  If the consignor fails to do so, it may find itself treated as a general unsecured creditor in the retailer’s bankruptcy.

Have you ever had a situation where you were unable to reclaim consigned goods provided to a retailer?