referenced TED MAX & ALAN MARTIN, SHEPPARD MULLIN
You’ve worked so hard to get your foot in the door with that prized retailer, striving mightily to please them. They’ve finally supported your line and you just shipped them a big order for Fall 2020. But that same retailer has now filed Chapter 11. What can you do to protect your inventory in the bankruptcy proceeding? Should you continue to do business with the retailer during the bankruptcy? And what can you do to avoid these problems in the future with other retailers? This article will briefly address these questions and provide some basic strategies to help guide the designer/manufacturer in these difficult times.
Getting Paid Before A Bankruptcy Petition Is Filed
Purchasing goods on a wholesale basis with a purchase order does not by itself afford protections for a designer/manufacturer. As discussed below, certain protections are afforded by the Uniform Commercial Code (“UCC”), which applies to the sales of goods, with respect to reclaiming goods. Before any bankruptcy is filed, care should be taken to be in communication with the retailer to ensure that the designer/manufacturer’s level of exposure is limited by inserting closer to delivery or COD payment terms and limits on the size of orders. Care should also be taken to monitor the financial condition and credit conditions of the retailer and the timing of payments, the source of payments and any change in purchasing patterns.
Tools To Ensure Payment
A designer/manufacturer can minimize risk of non-payment by requesting a letter of credit, a third party guaranty, surety or security. A letter of credit is a written undertaking from a financial institution to pay upon certain terms such as shipment and delivery of conforming goods. This will ensure payment even if the retailer is unable to pay but letters of credit are difficult to obtain as part of a retail transaction. A third party guaranty represents a promise by another party to stand in for the retailer and to make payment if the retailer defaults on its obligation of payment. Guaranties must be in writing and the terms and conditions of the guaranty should be carefully drafted. A surety entails contracting with a third party, such as a bonding company to be responsible for payment much as a guarantor is liable.
Consignment Arrangement
A consignment arrangement generally involves a seller (“consignor”) delivering goods to a consignee under a bailment arrangement where the consignor retains ownership while the consignee holds the goods for sale to consumers and the consignee shares the proceeds with the consignor. Under common law, the consignee’s rights in the goods are limited and creditors typically cannot successfully assert claims against the goods and the proceeds. However, if the consignment falls under Article 9 of the UCC, which relates to secured transactions, creditors of the consignee can assert claims against the consigned goods, notwithstanding the fact that the consignor has legal title, and can claim priority based upon a perfected lien and pre-existing security interests if the consignor has not filed a UCC-1 financing statement for such goods and provided notice of the consignment to creditors. Where the retailer has received financing and the financing entity has filed security interests in the retailer’s inventory and proceeds of sales, it is probable that financiers have security agreements in place and have liens against pledged assets. The use of a consignment agreement can be problematic because of the need for a UCC-1 filing and notice of the consignment to financing entities and, if a security interest were perfected with respect to goods that are currently in inventory, it is likely that a pre-existing security interest has been filed as to the purchased goods. In addition, in certain circumstances, assets in a bankruptcy estate may become encumbered by a super priority lien that supersedes all previously-filed security interests. Given the need for UCC-1 filings and notice to creditors, consignment arrangements are generally used with respect to higher-priced goods as opposed to goods which are sold at a high volume and lower prices.