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.
This ruling would remain the same
through several different orders entered
by the court through May 3, 2016.
The court also stated at the March 16
hearing that it would not expedite the
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