Journal of Corporate Renewal

October

2016

If the consignment vendor were to perfect its claim against the consignee, it would have a priority interest in the goods, whereby, absent a senior secured interest in the goods, the consignor would likely recover its full contractual claim. To perfect its interest against the consignee, the consignor must simply file a UCC financing statement.

The financing statement must be filed in the appropriate jurisdiction and must adequately describe the goods.

A consignor must meet additional requirements, however, to protect its interests in the goods against the consignee’s existing secured creditors that have a security interest in the consignee’s inventory. UCC § 9-103(d) provides that a consignor has a purchase-money security interest in goods that are the subject of a consignment, which, if perfected, has priority over conflicting security interests in the same inventory under UCC § 9-324(b). To obtain this priority, the consignor must have perfected its security interest (by filing a UCC financing statement) prior to the consignee’s receipt of the goods.

Additionally, the consignor must send an authenticated notification (again describing the goods) to the holders of conflicting security interests (e.g., a consignee’s secured lender with a lien on inventory) that states that the consignor has, or expects to acquire, a purchase-money security interest in the inventory.

The holder of the conflicting security interest must receive the notification within five years before the consignee receives possession of the inventory.

If the consignment vendor closely follows these procedures, the vendor should find itself in a strong position in any bankruptcy proceeding, as it will have a secured claim in the goods delivered to the consignee in accordance with its contract.

However, as demonstrated by Sports Authority, many vendors fail to observe these requirements and can find themselves embroiled in litigation in a subsequent bankruptcy.

Sports Authority

Sports Authority filed for bankruptcy in
Delaware on March 2, 2016. As of the
petition date, the debtors’ inventory
included approximately 8. 5 million units
of goods supplied on consignment from
approximately 170 vendors, with an
invoice price of approximately

$85 million. The consigned goods were delivered prior to the petition date pursuant to short-form agreements with Sports Authority that identified the arrangement as “a consignment as defined in Section 9-102” of the Colorado and Delaware UCCs, while also providing that the vendor shall retain title to all goods until the date of sale (when title would pass to the ultimate purchaser).

These goods would prove to be the center of a four-month-long dispute between the debtors, their consignment vendors, and their secured lenders.

Along with a number of other first-day filings, Sports Authority filed a motion that sought authority to continue selling the consigned goods in the ordinary course of business. This motion proposed to grant the consignment vendors replacement liens on the proceeds of the sale of the consigned goods, but only to the extent that such vendors had valid, enforceable, nonavoidable, and perfected liens in the goods delivered to the debtors. A large number of consignment vendors objected to the requested relief.

These consignment vendors argued, among other things, that the consigned goods were not property of the Sports Authority estate and thus could not be sold. They further argued that a determination of whether the consigned goods were property of the estate could not be made in the context of a contested matter, but instead must be made in an adversary proceeding.

Sports Authority’s secured term loan lenders also appeared. The secured lenders held a perfected lien on the debtors’ inventory, which purportedly included the consigned goods. At the first-day hearing the secured lenders stressed that $85 million in value was at stake that could either be the secured lenders’ collateral or the property of the consignors. The secured lenders stated that they could not consent to pay potentially unsecured creditors with what may be collateral, but that the idea of the debtors’ motion was to put this issue off for another day.

After much discussion, the Bankruptcy
Court allowed Sports Authority to sell
the consigned goods on an interim
basis while placing the proceeds of
such sales in escrow. Subsequently, on
March 10, certain of the consignment
vendors and the debtors submitted
competing forms of proposed interim
orders. On March 11, in what proved to
be a turning point in the dispute, the
court entered the consignment vendors’
form of order. Significantly, this form
allowed the vendors to prohibit the sale
of the consigned goods and required
that Sports Authority segregate the
goods and provide an accounting of
the goods to the applicable vendors.

Segregation of the goods was not a practical possibility for the debtors.

The debtors immediately made an oral motion for reconsideration, and the court conducted an emergency telephonic hearing. After that hearing, the court issued a revised order striking the vendors’ right to prohibit the sale of the consigned goods from the order and scheduled another hearing for March 16, at which the court would consider what procedure would be followed if a consignor provided notice to Sports Authority to cease selling the consigned goods.

On March 15, Sports Authority filed approximately 160 adversary proceedings that generally alleged that the consignment vendors did not observe the UCC perfection protocol with respect to the consigned goods, by either failing to properly record their consignment interests and/or to notify the secured lenders of their interests. Based on these facts, Sports Authority sought orders declaring that the vendors held no more than general unsecured claims against the debtors.

Despite the existence of the adversary proceedings and the arguments advanced by Sports Authority and the secured lenders, at the March 16 hearing, the court ruled that Sports Authority was required to choose one of three options with respect to treatment of the consignment vendors. They had to (i) settle with the consignors, (ii) return their goods, or (iii) continue to sell the goods in accordance with the prepetition consignment agreements. Presented with that choice, Sports Authority chose to continue to sell the goods in the ordinary course of business and to pay the vendors as provided in their contracts (with those payments subject to claw-back) pending a final hearing.