Scott Chait,
Attorney,
Sumitomo Mitsui Banking Corporation

Retaining the services of an agent to remarket equipment is one of the more routine occurrences in the equipment finance and leasing industry, yet many may be surprised to learn it is fraught with potentially enormous legal risk — the loss of the equipment to a creditor of the remarketer. This article will briefly highlight the legal risk and, more importantly, recommend steps you should take to ensure your equipment is not subject to potential seizure by the remarketer’s creditors.

Upon a default and repossession, or at the end of a lease term, equipment finance and leasing companies will routinely retain the services of third-party vendors to remarket and sell the equipment on the lessor’s behalf. While the lessor maintains ownership of the equipment until it is ultimately sold, the remarketer will usually take possession to conduct the services.

During this period of possession, a lessor’s equipment could potentially be subject to a claim by the remarketer’s creditors, particularly in cases where applicable law would

deem the relationship between the lessor and remarketer to be one of ‘consignment.’ This is especially concerning in certain cases, such as vendor financing, where the remarketer is not outwardly in the business of remarketing equipment or selling equipment on behalf of others.

Assuming you have an “Article 9 consignment,” a creditor of the remarketer could have a “superior interest” in your equipment, unless certain steps are taken that mirror the necessary steps to perfect a purchase money security interest (PMSI) in inventory.¹ That, of course, means on or before delivery of the equipment to the remarketer, you must: file a financing statement against the remarketer, conduct a Uniform Commercial Code (UCC) search against the remarketer and then issue “PMSI Inventory Letters” to any of the remarketer’s creditors of record who have a conflicting security interest in the equipment.

In doing so, keep in mind some useful practice tips:

1. It’s not required to use the term “security interest” or “consignment” in your PMSI Inventory Letters² (i.e., “…has or expects to acquire a purchase money security interest in and to the following inventory…” versus “…has delivered or expects to deliver goods, properly described, on consignment…”).³
2. When filing your UCC-1, make sure to select consignor/consignee, not secured party/debtor.
3. Get an acknowledgment that you will be filing and issuing the letters, especially considering that the UCC rules of attachment, which, among other things, require a signed writing, may apply⁴ as between the parties.⁵

What exactly is a consignment and how might a remarketing scenario trigger it? Properly understood, a consignment is a bailment — a transaction in which one person (the bailor) delivers goods to another (the bailee) for a limited purpose — in which the limited purpose is for the bailee to sell the goods, but it is not a sale to the bailee.⁶ Some consignments are governed by Article 9 of the UCC. These are often referred to as “Article 9 consignments.” Other consignments — “true consignments” — fall outside of Article 9’s definition of “consignment” and are governed by non-UCC law.⁷

It is these Article 9 consignments that should be of particular concern to lessors who remarket equipment through a third party. Under Article 9, a “consignment relationship” is deemed to have been created between the lessor and remarketer if the remarketer is a merchant⁸ that deals in goods of that kind under a name other than the person making delivery, is not an auctioneer and is not generally known by its creditors to be substantially engaged in selling the goods of others.⁹

Taken together, a consignment relationship is created if a remarketer is not an auctioneer, sells equipment under its own name (or at least not in the name of the lessor) and is the type of company that appears on its face, in the eyes of its creditors, to be selling equipment for its own account. Notably, the equipment must be delivered to the remarketer “for the purpose of sale.”¹⁰ If the equipment is delivered for another purpose as well — in a typical equipment finance scenario, for example, the equipment may be delivered for inspection or appraisal purposes as well as remarketing — it’s still a consignment because a purpose of the delivery is to sell the equipment.¹¹ Also, the parties’ “intent” is generally not persuasive and sometimes deemed irrelevant, meaning that even if your contract with the remarketer clearly provides that there is no intent to establish a consignment, that clause will not control vis-à-vis third-party creditors of the remarketer¹² — and for good reason.

While at first glance it seems preposterous the relationship between you and your remarketer could be one of a consignment, reasoned public policy supports the rules. Since a consignee is clothed with apparent ownership of goods on hand, consignments could give rise to “secret liens.” So, Article 9 of the UCC brings all such transactions within scope.¹³

It is worth noting the official comments to the UCC, as they may provide another “out” for lessors looking to avoid the consignment trap: “If a merchant-processor-bailee will not be selling the goods itself but will be delivering to buyers to which the owner-bailor agreed to sell the goods, the transaction would not be a consignment.” In other words, if the remarketer is really just a “middle man” and the lessor handles the actual remarketing, negotiating and contracting, the law might not consider the transaction a consignment.¹⁴ Therefore, how you structure the remarketing could be key. That said, relying on a somewhat general statement in the official comments, which is likely to involve a fact-intensive analysis, could be risky.

So, what could happen if lessors do not take such actions? Traditional equipment dealers and remarketing agents are less likely to be deemed to be functioning in a consignment capacity because they are likely to be generally known by their creditors to be substantially engaged in the selling of goods of others. However, a manufacturer or vendor that generally sells only its own equipment may present a problem. This is particularly relevant in vendor finance programs in which the lessor may seek to use the original vendor of the equipment for remarketing and resale. It may be difficult to argue such an equipment manufacturer or vendor is known by anyone — let alone its creditors — to be in the business of selling the goods of others.

Of course, the determination ultimately must be made on a case-by-case basis, as it can be a fact intensive analysis. Unfortunately, there is a fair amount of conflicting litigation on the topic. For example, some courts have determined evidence of general knowledge within the industry is insufficient — rather, you must prove a majority of creditors were aware.¹⁵ Other courts have determined general knowledge within the industry was indeed enough.¹⁶ And yet, other cases don’t even apply the objective standard of what the general creditor body knew; instead they apply a “subjective” standard — did the competing secured creditor have “actual knowledge” of whether or not the consignee was substantially in the business of selling goods of others?¹⁷ To be sure, in January 2019, the Permanent Editorial Board for the UCC issued a commentary rejecting the subjective standard and even amended the official comments.¹⁸ Nonetheless, the conflicting case law remains.

Lessors should consider taking the preventative steps mentioned here to protect themselves no matter the type of relationship they are entering into with the remarketer. Keep in mind, such steps may be impractical for a variety of reasons, including pushback from the remarketer or the cost and effort involved. Therefore, the lessor may make the business decision to risk-accept and forego following these steps. However, in such cases it may behoove you to at least determine the scope of prior creditors who have filed financing statements against the remarketer. Generally speaking, this is an easy, quick and cheap search resulting in a digest of filed creditors. While case law may not be supportive of this mitigant,¹⁹ consider having the remarketer tag or otherwise clearly ID your equipment in the hope that such a designation would be effective.

Finally, note the consignment rules are of limited application. Article 9 only applies to consignments to the extent of determining the rights of creditors of, and value purchasers from, the consignee (remarketer). Other law governs other purposes, such as the contractual relationship between consignor (lessor) and consignee (such as the consignor’s remedies).²⁰

The bottom line is consignments can be quite tricky and inadvertently triggered in remarketing situations. Prompt action by a lessor, especially in cases of vendor finance, to follow the PMSI inventory rules and other mitigants may prove vital in safeguarding your rights if a remarketer finds itself subject to a claim by its creditors.

¹See UCC §§ 9-103(d), 9-109(a)(4), 9-319(a) and cmt 2; 9-324(b)–(c) and cmt 7

²Although not required, it is always a best practice for a lessor to specifically mention its ownership and/or security rights to equipment in a PMSI inventory letter to ensure all parties understand the nature of the interest being claimed.

³See id. § 9-324, cmt 7.

⁴While we’re not aware of any specific law requiring the consignee’s consent for you to file a UCC-1 and issue PMSI inventory letters, cmt 6 to UCC § 9-102 states that “[t]he interest of a consignor is defined to be a security interest under revised Section 1-201(37), more specifically, a purchase-money security interest in the consignee’s inventory. See Section 9-103(d). Thus, the rules pertaining to lien credits and buyers and attachment, perfection and priority of competing security interests apply to consigned goods.” (emphasis added).

⁵See UCC § 9-203(b) for the elements of attachment: (1) value has been given by the debtor; (2) the debtor has rights in the collateral; and (3) the debtor has authenticated a security agreement describing the collateral. The third element is the typical method of achieving attachment of a security interest in certain types of collateral (such as equipment and inventory) where the security interest does not automatically attach by possession or control. Note that the UCC uses the term “authenticate,” but for the most part, this simply means that the debtor must sign the agreement.

⁶See Permanent Ed. Bd. For the UCC, PEB Comment No. 20 Consignments Jan. 24, 2019, 2 (Am. L. Inst. and Nat’l Conf. on Unif. State L., 2019).

⁷See UCC § 9-102, cmt 14 (“A consignment excluded from the application of this Article by [§ 9-102(a)(20)(B) or (C)] may still be a true consignment; however, it is governed by non-Article 9 law.”) Non-Article 9 law may be provided by another statute or by a rule of common law. For example, many states have non-UCC statutes governing the relationship between artists and art dealers.

⁸The UCC defines a “merchant” as “a person who deals in goods of the kind or otherwise by [their] occupation holds [themselves] out as having knowledge or skill peculiar to the practices or goods involved in the transaction or to whom such knowledge or skill may be attributed by [their] employment of an agent or broker or other intermediary who by [their] occupation holds [themselves] out as having such knowledge or skill.” UCC § 2-104(1).

⁹See UCC § 9-102(a)(20). The equipment must also have a value of at least $1,000, not be consumer goods and the transaction may not create a security interest that secures an obligation.

¹⁰Id.

¹¹See supra note 4.

¹²See, e.g., In re Pettit Oil Company, 917 F.3d 1130, 1134 (9th Cir. 2019); In re TSAWD Holdings Inc., 595 B.R. 676 (Bankr. D. Del. 2018); In re Wolverine Fire Apparatus Co. of Sherwood Michigan, 465 B.R. 808, 820 (E.D. Wis. 2012); In re Valley Media, Inc., 279 B.R. 105, 125 (Bankr. D. Del. 2002).

¹³See UCC § 9-109(a)(4).

¹⁴See supra note 4.

¹⁵See, e.g., In re Downey Creations, LLC, 414 B.R. 463, 467, 471 (Bankr. S.D. Ind. 2009).

¹⁶See, e.g., Overton v. Art Fin. Partners LLC, 166 F. Supp. 3d 388, 410 (S.D.N.Y. 2016) (“Such undisputed facts suggest that Sammons was known within the art world — even to those who did not know him well — as someone who transacted as a fine art agent. Thus, it stands to reason that fine art creditors would be aware of the nature of Sammons’ business.”).

¹⁷See, e.g., In re TSAWD Holdings Inc., 595 B.R. 676, 683 (Bankr. D. Del. 2018); Fariba v. Dealer Servs. Corp., 178 Cal. App. 4th 156, 159, (2009); Eurpac Serv., Inc. v. Republic Acceptance Corp., 37 P.3d 447, 451 (Colo. App. 2000).

¹⁸See supra note 3.

¹⁹See, e.g., Vonins, Inc. v. Raff, 101 N.J. Super. 172, 182 (App. Div. 1968) (“New Jersey does not have ‘an applicable law providing for a consignor’s interest or the like to be evidenced by a sign.’”); In re Levy, No. 29054, 1965 WL 8369 (Bankr. E.D. Pa. Dec. 13, 1965) (“[The court’s] search has not disclosed that Pennsylvania has enacted any sign law applicable to consignments of the type of goods which is the subject matter of this proceeding . . . ”).

²⁰See UCC §§ 9-319; 9-109, cmt 6.

About the authors: Scott Chait is an attorney with Sumitomo Mitsui Banking Corporation. Shari Bacsardi and Dillon Redding serve in Womble Bond Dickinson’s Capital Markets Practice Group as a partner and member, respectively.

The views expressed in this article belong solely to the authors and do not necessarily represent the views or position of their employers or any other person.