How To Lose Your Consigned Merchandise

Perhaps you’re an artist who has placed some paintings with a gallery for sale.  Or maybe you design enamelware, or create jewelry, or manufacture handmade books, and you’ve left several items with a handicrafts shop on consignment.  You’ve put labels on each item stating that it belongs to you, and not to the shop or gallery.  The owner of the shop or gallery has promised to pay you a percentage of the sale price of each item sold.  You have a written consignment agreement.  You’re OK, right?

Not so.  Did you know that if the shop or gallery goes bankrupt, you’ll probably never see those items again?

 How Bankruptcy Works

You may know that when a store goes bankrupt, all of its loans are canceled, all of its assets are sold, and the store’s lenders and creditors receive the proceeds from the sale — often just a few cents on the dollar.  In the past, some lenders have tried to avoid having their loans canceled by instead consigning merchandise to stores.   A retail store would receive products on consignment from the manufacturer, who would retain ownership of the products.  The retail store would only pay for the products when they were sold.  If the retail store went bankrupt, the manufacturer then would argue that it still owned the products and so was entitled to have them returned.

The law, however, eventually came down hard on this tactic.  After all, a piano manufacturer who sends pianos to a music store “on consignment” is not very different from a piano manufacturer who sells pianos to a music store on credit.  In either case, the piano manufacturer is essentially financing the music store.

For this reason, consignments are by default treated like loans under bankruptcy law.  Which means that if you consign goods to a shop, and that shop goes bankrupt, you generally won’t get your goods back.  Instead the bankruptcy trustee will sell your goods along with all the rest of the shop’s assets, and then you’ll get to share in the proceeds along with all the other people to whom the shop owes money.  Usually you’ll only get back pennies on the dollar.

(The only exceptions to this are when the shop is an auctioneer or when the shop’s creditors generally know that it is substantially engaged in selling things for other people.  These are pretty narrow exceptions, and in our experience they don’t often apply.)

How to Protect Yourself

The only way to protect yourself from this is to have a written agreement with the store, and to file a UCC financing statement as part of your consignment arrangement with the store.  The UCC financing statement will identify you and describe your consigned goods.  In Virginia, you will file the UCC Financing Statement with the Virginia State Corporation Commission at a cost of $20.  Your filing will put the whole world on notice that you own the consigned goods, and will prevent the bankruptcy trustee or another creditor from seizing them.  However, you have to do this before providing any consigned goods to the store.

You also should search through the UCC financing statements that other creditors of the store already may have filed.  If there is a creditor that already has a collateral interest in the store’s inventory, then you need to notify that creditor in writing after you file your financing statement.

Don’t forget to file a UCC continuation statement every five years (along with notice to other creditors who have a collateral interest in the store’s inventory).  And don’t forget that if the store changes its name, identity or corporate structure, then you have only four months to file an amended UCC financing statement.

If you follow these steps, and if you have a clear and comprehensive consignment agreement, then you should be able to consign your artwork, handicrafts or other goods without fear.