In a soon to be published opinion, IPC (USA), Inc. v. Ellis (In re Pettit Oil, Co),[1] the Court of Appeals for the Ninth Circuit determined that the definition of “goods” as used in U.C.C. § 9-319(a) includes “proceeds– i.e., money and accounts receivable generated from the sale of goods.
Under bankruptcy law, if a consignee files for bankruptcy, any consigned “goods” in its possession become property of the bankruptcy estate unless the consignor has previously provided public notice of, and perfected its interest in, the goods. In In re Pettitt Oil Co., the Court of Appeals considered whether U.C.C. § 9-319(a), which grants a consignee “rights and title to the goods,” also grants the consignee an interest in the proceeds of those goods that were generated prior to a bankruptcy filing. In holding that the liquidation trustee for Pettit Oil Company (the “Debtor”) was entitled to retain approximately $5.5 million in cash and accounts receivable that the Debtor owed to a fuel supplier when the Debtor filed for bankruptcy, the Court of Appeals essentially clarified that the rules governing secured transactions, as laid out in Article 9 of the U.C.C., also govern “consignment transactions.”
Prior to filing bankruptcy, the Debtor, a distributor of bulk petroleum products, entered into a consignment agreement with IPC (USA), Inc. (“IPC”), whereby the Debtor stored and distributed IPC oil products. When the Debtor filed bankruptcy, it possessed fuel and proceeds from the sale of IPC’s fuel in the form of cash and accounts receivable. After the Debtor filed for bankruptcy, the liquidation trustee (the “Trustee”) commenced an adversary proceeding seeking the value of the fuel in the Debtor’s possession at the time of the bankruptcy filing, as well as the value of the accounts receivable and cash proceeds related to the oil products, for the benefit of the bankruptcy estate.
The Trustee’s adversary proceeding centered on a primary tenant of bankruptcy law, section 544(a)(1) of the Bankruptcy Code, which provides that when a debtor files bankruptcy, the bankruptcy trustee is granted a judicial lien over all property the debtor owns as of the petition date. The Trustee claimed that IPC’s interest in the fuel and proceeds was subordinate to the estate’s interest because (1) the estate had an ownership interest in the property, pursuant to U.C.C. § 9-319(a), which provides “for purposes of determining the rights of creditors of . . . a consignee, while the goods are in the possession of the consignee, the consignee is deemed to have rights and title to the goods identical to those the consignor had”; (2) a creditor wishing to shield assets from the reach of the Trustee may only do so by demonstrating that it has priority superior to the judicial lien arising under section 544 of the Bankruptcy Code; (3) IPC never filed a financing statement or perfected its interest in the consigned “goods”; and (4) therefore, the Trustee’s judicial lien was superior to any interest held by IPC. The bankruptcy court granted summary judgment in the Trustee’s favor, and a Bankruptcy Appellate Panel affirmed. IPC appealed.
On appeal, IPC argued, among other things, that because the drafters of U.C.C. § 9-319 used the term “goods” as opposed to “goods and proceeds,” Article 9 cannot dictate the treatment of proceeds of consigned goods, and, accordingly, the Trustee had no right to retain the cash and receivables generated from the sale of IPC’s fuel. In other words, IPC asserted that U.C.C. § 9-319 did not apply to proceeds because proceeds were not “goods.”
The Court of Appeals disagreed, however, calling IPC’s interpretation of 9-319 “strained.” The Court determined that “under [U.C.C. § 9-319] even though the consignee doesn’t actually own the goods, he is treated as having an ownership interest” and “the most natural reading” of Article 9 is that “a consignor’s interest in goods (and the related proceeds) is a security interest for all purposes—including for purposes of perfection and priority—unless the U.C.C. specifically says otherwise.”
As a result, the Court of Appeals unequivocally held that the term “goods” in U.C.C. § 9-319 includes the proceeds from such goods, and that the priority and perfection rules relating to consignments apply equally to goods and proceeds. The Court opined that its interpretation is consistent with the rationale behind the U.C.C. and protects the delicate balance that the U.C.C. drafters struck between the interests of a consignor and a consignee’s creditors. To the outside world, goods in possession of a consignee are property of the consignee, and creditors might reasonably believe as much when they decide to lend the consignee money. A consignor having a perfected security interest in the goods puts potential creditors on notice about the true ownership of the goods, and absent such notice, unwary creditors are protected from lending money based upon property with encumbered by “secret liens.” Accordingly, the Court of Appeals’ decision has further confirmed that a consignor must be especially wary when conducting business with a consignee in a distressed industry or environment.
[1] IPC (USA), Inc. v. Ellis (In re Pettit Oil, Co), No. 17-60081, 2019 WL 1104662 (9th Cir. 2019) [ECF No. 41].