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

(This is the third in a series of columns that deals with contemporary legal and commercial issues that are currently facing the diamond and jewelry industry and I invite reader email responses and dialogue regarding the issues raised. Please see the previous article in the May 2015 edition, page ___).

We left off last time discussing the “Inter-creditor Agreement” that are demanded by many of your customers’ lenders and my suggestion that you not sign. At first glance an inter-creditor agreement seems innocuous, in that it reserves your right to maintain an interest in your consignment goods. However, it also expressly makes clear that your interest in your consignment goods applies only as long as your goods remain “on consignment”. When exactly “on consignment” terminates is a matter of legal dispute; many bankrupt debtor’s attorneys have insisted that since the bankrupt has the ability to sell the goods, the debtor has acquired an interest in those goods and the goods are no longer “on consignment”. In addition, the inter-creditor letter agreement makes it clear that until the lender is fully paid, you, the other creditor with a competing interest in the consignment goods, will not seek to make any claim against the debtor or the interest of the lender.

Although the lender is not telling you so, it is relying on the receivables of the sale of your consignment goods to extend credit to your customer. The receivables of your consignment goods provides the lender with additional collateral against money lent to your customer. Your customer gets a larger line of credit and its lender gets more collateral to go after. Both are benefiting from your capital assets and should have no right to require you to relinquish your purchase money security priority position on your consignment goods.

Returning back to our main discussion of filing the UCC-1, once you have filed your UCC-1 and have complied with all the procedural requirements to get a PMSI, you must keep in mind that your security interest is valid only as long as the goods remain in your customer’s possession and have not been sold to its customer. Therefore, it is imperative that you require sales reports as frequently as possible. You should request biweekly or monthly sales reports, immediately issue invoices for all goods that are reported sold, and maintain a close watch on how much goods are being extended on consignment, and how much monies are owed to you for goods already sold. It is not uncommon for a supplier to set a goal, perhaps let’s say $100,000 for a particular customer, but because of the drag time between the report, the issuance of the invoice, the request by the customer for additional replenishment of goods sold and the receipt of payment, that the total amount provided to the customer and outstanding at any one time is $150,000 or more.

You must keep on top of the outstanding invoices, and the payment terms and insist that the terms agreed to be strictly complied with. In the event of a bankruptcy, any payments that were made to you in the normal course of business under the terms of your consignment agreement will not be recoverable by the trustee in bankruptcy, but if the payments were made beyond the terms agreed to, or sporadically instead of each month, the trustee in bankruptcy will demand, the return of such payments. For example, if your agreement with your customer is that all invoices will be paid within 30 days of the date of receipt of the invoice by the customer, and you allow him to pay, sometimes 40 days, sometimes 60 days, the court may consider this not “in the normal course of business” and recoverable by the trustee.

If, after a brief explanation to your customer why you are requesting to file the UCC, your customer insists that he does not allow UCC’s to be filed on his business, or refuses to allow you to maintain a lien on your consignment goods despite the widely accepted practice throughout the entire United States, you should be wary of providing any substantial amount of goods to such customer, and understand that you are totally unsecured and the goods you a providing to such customer are subject to the prior claims of such customer’s lender and other creditors.