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

(This is the eighth 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).

These articles for information and discussion purposes only and should not be construed as legal advice, which advice shall be provided only after entering into a written retainer agreement.)

In a case that originally appeared before the Southern District of New York in2014 and recently was reversed on appeal by the US Court of Appeals for the Southern District, the Appellate Court ruled contrary to the finding of the judge in the Southern District that the pendant belonged to the consumer- purchaser, the Original Dealer who gave the pendant out on memo is the rightful owner and the consumer purchaser must return the pendant.

You may say to yourself – of course. He gave it out on Memo and never issued an invoice and never received payment from the Consignee who later absconded with the pendant which, after changing hands over multiple wholesale transactions, was ultimately sold to the innocent, consumer- purchaser. After all, you reason, it is only common sense that the Consignee “stole” the pendant from the dealer and isn’t it true that a “thief” who steals an item cannot transfer title he himself never acquired?

Well one of the first things lawyers are taught in law school is that the “Law” is NOT based on common sense. It is a system of justice based on statute and legal precedence.

Under Section 9-319 of the Uniform Commercial Code (“UCC”), once goods are consigned to a Consignee who takes possession of the goods and the consignor (i.e. the dealer) has not perfected his interest (see previous articles on filing a UCC-1 and acquiring a Purchase Money Security Interest), “…the consignee [i.e. the recipient of the memo goods- LW] is deemed to have rights and title [emphasis added] to the goods identical to those the consignor had or power to transfer”. As the Official Comments to the UCC make clear, “…creditors of the consignee can acquire judicial liens and security interests in the goods.” What this means is that once you give goods out on memo, despite all the language of “reserving title and no right to sell” generally contained in the pro forma legal text of your memos, the consignee(the person you gave the goods to), under the UCC, has acquired an “interest” in your goods giving him a right to transfer title and leaving you only a claim as an unsecured creditor of the consignee.

But if that is true, what was the lawsuit about? The initial decision of the judge in the Southern District Court should have been correct. The innocent, consumer-purchaser who was a “buyer in the ordinary course of business”, which is defined in the Official Comments to Section 9-320 as one who buys goods “in good faith, without knowledge that the sale violates the rights of another person”, (which all parties to the lawsuit concede was the case), should have won the lawsuit.

There are two other provisions in the UCC, however, Sections 2-104 and 2-403 that the Appeals Court felt were determinative of this dispute. Section2-403(2), states “any entrusting of possession of goods to a merchant [emphasis added] who deals in goods of that kind gives him power to transfer all rights of the entruster to a buyer in ordinary course of business.”

“Entrusting” is defined in subsection (3) as “…any delivery and any acquiescence in retention of possession regardless of any condition expressed ….regardless of whether the procurement of the entrusting or the possessor’s disposition of the goods have been such as to be larcenous under the criminal law”.

Section 2-104 defines “Merchant” as both “…a person who deals in goods of the kind or otherwise by his occupation holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction.The Official Comments state that the rules regarding professionals may not apply to casual or inexperienced seller or buyer.

As in all good legal cases, the outcome of any lawsuit hinges on the facts of the case as much as the law. In this instance, the facts underlying the case were quite unusual.

The facts: The Consignee turns out to be a “fashion stylist” whose business was to outfit his clients for celebrity events and photo shoots, often using consigned jewelry. Through the wearing of its diamond jewelry by celebrities, the Original Dealer hoped to boost its image, prestige, and presumably, ultimately, its profits.

The consignment was made pursuant to a standard memorandum that the stylist executed which contained the language we are all familiar with, namely, …”this is not an invoice or bill of sale,. …no right or authority to sell, pledge, hypothecate or otherwise dispose of the merchandise, or any part thereof”; that any sale of the merchandise “shall occur only if and when the stylist shall have received from the Original Dealer a separate invoice covering specific merchandise on the memorandum”; and that the agreement was governed by New York law.

The Original Dealer became worried when the stylist, atypically, failed to return the Diamond on time. The Original Dealer reported the disappearance of the Diamond to the New York City Police Department and later reported the theft to the Gemological Institute of America (the “GIA”), which maintains a database of stolen diamonds and other jewelry. The stylist was subsequently caught and convicted of the theft of many jewelry items from multiple dealers, including the Diamond from the Original Dealer.

The Diamond had apparently been sold by the fashion stylist to a NY dealer who sold it in turn toa jeweler and it eventually ended up in the hands of a private couple who submitted the stone to GIA for re-certification and were told the stone had in fact been stolen and that GIA would retain possession of the Diamond pending a final resolution of its rightful owner.

The crucial issue before the Appeals Court was whether the fashion stylist qualified as a “Merchant” who could pass title to the Diamond. In other words, “did he deal in goods of that kind’ to meet the definition of such a merchant who could transfer title. Without going into a more lengthy legal discussion of the different applicable provisions than has already been presented, the Court of Appeals finally concluded that a merchant who “deals in goods of that kind” is one who “regularly” sells those goods, and this “fashion stylist” never actually sold any of the jewelry he took on memo. As a result, he did not possess the legal right to transfer title to anyone, and the Diamond must be returned to the Original Dealer and the private couple is out of luck.

BOTTOM LINE: Do not rely on the language of your memos to protect your consignment merchandise. The “Law” is not common sense. It is essential that you have an experienced attorney review your consignment programs and develop a comprehensive security plan.