If your customers are experiencing financial difficulties, they may suggest changing their credit terms with you. Other times it may be you who suggest changing the terms in order to reduce risk. One arrangement to be wary of though is any in which you supply the goods on a consignment basis. This may seem to be in the interest of both parties, wherein you keep a valuable customer and they can continue to sell your product. Although your goal was to reduce risk, you may inadvertently open yourself up to the same credit extension risk you had before.
Disguised Secure Transactions
The idea behind true consignment is that your customer takes on minimal upfront risk and you have another avenue to sell your product. If the product can not be sold, then it is just returned back to you. In the eyes of the court, these four characteristics are most often used to determine if the relationship is actually a real consignment:
- Your customer only has to pay for the product if the product sells
- You decide the price at which the good will be sold
- Your customer must get your permission before it sells the good
- Your customer is required to segregate the product from its other goods
The problem with this is that many credit arrangements fail to implement some, if not all, of these requirements. So even if you and your customer call your agreement a consignment, the courts may have a different opinion. In their eyes these deals are disguised secure transactions and thus you will receive no preferences in the handling of your “cosigned” goods in any bankruptcy proceedings. To avoid this, you should comply with Article 9 of the Uniform Commercial Code and file a UCC-1 financing statement.
What is Article 9 of the UCC
Under the most recent revisions to Article 9 (effective July 1st, 2013 in most jurisdictions), most forms of consignment, even those that abide by the above mentioned characteristics, are classified as security interest obtained through the financing of the debtors purchase of the underlying collateral. In the eyes of the law, this means that unless you have filed a UCC-1 financing statement, even a real consignment agreement may not grant you any preferential treatment in bankruptcy proceedings.
The UCC-1 financing statement is a legal form that a creditor files in order to give notice that they may have interest in the property of a debtor. This form may be avoided, but only if the value of the goods in question is less than $1000 per delivery or if the retailer is known to engage in consignment agreements with its suppliers.
What Should you do
Due to Article 9, most consignments agreements, real and the disguised secure transactions mentioned above, are simply considered secure transactions. Under this agreement in the UCC, banks with a security interest in the your customer’s inventory are given a priority interest in your product during bankruptcy proceedings. In order to avoid this situation, you must file a UCC-1 financing statement and provide notice to these banks that you intend to keep an interest in your goods. By doing this, you can protect yourself if your customer were to file for bankruptcy. Here are some other things you can do to minimize any loss from a customer filing for bankruptcy.
As always, it is best to contact a lawyer if you are considering such transactions. It is always best to act proactively before you find yourself in a situation where you lose inventory you thought you still owned.