In My Legal Opinion….By Leonard M. Weiner, Esq., PhD.

This is the first of a series of columns that will deal with contemporary legal and commercial issues that are currently facing the wholesale diamond and jewelry industry and I invite reader email responses and dialogue regarding the issues raised.

The issue I would like to begin discussing in this initial column is the practice of providing customers goods on Consignment. There are a number of other industries that offer their products through the means of “Consignment” or “Memo”, such as the art world, or furriers, but none have anywhere near the financial exposure and capital risk as the diamond and jewelry industry. It is not unusual to have hundreds of thousands, if not millions of dollars of merchandise on memo at any one time, sometimes with a single customer, and certainly with multiple customers, with little or no security or protection in the event of failure to pay or return the goods, or even worse, bankruptcy. 

Unfortunately there are still many in the industry who are living in the “Middle Ages” when it comes to the “All–Risk for Inspection Only Memos” and believe that the old legal language that they copied and recopied from each other and have printed on their memorandums since before the Roosevelt era (I mean Teddy not Franklin) will somehow protect them from loss and provide them with security when in fact Article 9 of the Uniform Commercial Code (the “UCC” -almost universally accepted as the commercial law in every state in the US) expressly made clear under old Section 2-236(3)and re-codified in different language under Revised Article 9 (Section 9-318) that goods provided on memo (by you) are subject to claims of your customer’s creditors even though an agreement (your old legal language) purports to reserve title or uses such terms as “on consignment” or “on memorandum”. As the Official Comments to Revised Article 9-318 point out, the consequences of this provision are that the creditors of the Consignee (your customer) can acquire judicial liens and security interests in the consigned goods.

Recognizing the total unfairness of this provision, the UCC provides the Consignor (you) with a system to file a security interest in the consignment goods and keep such goods out of the reach of your customers’ creditors- thus was born the UCC-1 or UCC Financing Statement. Each state has set up a UCC filing system, usually with the Secretary of State’s office in such state, where all parties wishing to file a security interest in named collateral may, with the consent of the customer, do so, thus “perfecting” their security interest in the collateral (in the case of consignments, the consigned goods) and providing the Consignor (you) with a priority claim on such collateral in the event of claimsagainst your customer by unsecured creditors.

But you may ask, what about competing claims by other secured creditors on the same collateral? How is that possible you wonder –how can another creditor of my customer file a secured claim on MY consignment goods if I filed a UCC-1 as described above?The answer is a secured creditor of the same customer who filed first (the UCC provides priority of competing claims based on chronological filing; whoever filed first comes first) and you can rest assured that most of your customers have operating loans and other financing agreements with lenders who filed blanket liens on all inventory, receivables, assets etc. before you filed and therefore even if you filed, the bank will more than likely sweep up all of the inventory, including the consignment inventory leaving you with nothing but frustration and regrets.

Ah you may say, that is again totally unfair and you would be right. No seasoned businessman (outside the diamond and jewelry industry, perhaps) would ever expose himself to such chance of forfeiture, and this would be the end of any consignment business in the US. Not wishing to stymie trade and recognizing the need to incentivize a supplier to provide goods on consignment by giving him a way to secure his consignment merchandise, the UCC introduced a “silver bullet”-
“The Super Priority Secured Interest” –able to leap-frog over all previous filed competing secured creditors- the “PMSI” –the purchase Money Security Interest.

What exactly that is, how to get one, and the pitfalls for the inexperienced, lawyers included – stay tuned. [To be continued] [I can be reached at lenlaw@verizon.net]