Unperfected Consignment Liens and Priority
A lender may not be a retailer’s only secured creditor. Often, retailers have consignment agreements on their inventory, and those consignors have secured interests in the consigned inventory. As a result, consignment agreements may affect a lender’s recovery if the retailer enters bankruptcy. Typically, competing secured creditors can look to the Uniform Commercial Code (the “UCC”) general rules of priority for conflicting security interests, but these rules may not apply to consignment arrangements.
In the case of In re TSAWD Holdings, Inc., the United States Bankruptcy Court for the District of Delaware considered whether the UCC’s general priority rules apply to a consignment agreement when the agreement’s UCC filing has lapsed. A sporting goods and active apparel retailer sold merchandise on consignment and had several term loans. The consignor filed a UCC-1 financing statement when the agreement was made but allowed it to lapse, causing its interest to become unperfected. When the retailer filed for Chapter 11 bankruptcy, the agent for the retailer’s term loans challenged the consignor’s priority to proceeds of the sale of the retailer’s consigned goods.
The term loan agent argued its perfected security interest should be superior to the consignor’s unperfected security interest. The consignee argued that even though its security interest had lapsed approximately two years earlier, the term loan agent cannot be superior to it since the term loan agent funded the retailer’s loans with the knowledge that the retailer had a consignment arrangement with the consignor.
Under the UCC, a perfected security interest typically has priority over a conflicting unperfected security interest. However, if a consignor can demonstrate the consignee’s other secured creditors knew a consignment arrangement existed, the consignor’s security interest will not be inferior to the other creditors’ security interests by virtue of the consignor’s interest being unperfected. The UCC’s priority rules are meant to protect creditors from “secret” or “hidden” liens. A consignor’s security interest that became unperfected is not “secret” or “hidden” if the consignee’s other secured creditors constructively or actually knew of its interest.
When a lender extends credit based on collateral that includes inventory likely to be the subject of a consignment agreement, the lender must go beyond conducting a UCC search to determine whether its UCC filings will give it priority if the debtor defaults. A consignor’s rights are paramount, and lenders should plan accordingly. The author thanks law clerk Jozie M. Barton for her assistance with this article.