Consignments; Consignment Sales

Under consignment terms, the consignor [meaning the supplier] ships goods to the consignee to sell. The supplier retains title to and ownership of the merchandise until the goods are sold to a third party. The consignee makes payment to the consignor only when the goods are sold.  Consignments are not true sales because title does not pass to the consignee.  The consignor is usually liable for the cost of freight to ship their goods to and from the consignee.

To protect its interests, the seller usually files a UCC-1 financing statement for the consigned inventory.   This UCC-1 describes the inventory and clearly states or explains that the owner of the inventory is the assignor and the party currently holding the inventory is in fact a consignee. 

Article 9 of the Uniform Commercial Code (UCC) contains the requirements for perfection by a consignor (the seller) which is the means by which a creditor/seller established that it has a valid and enforceable security interst in it consigned inventory.  There is no obligation on the part of the consignee to buy the goods.  Instead, the consignee has an obligation to either:

(a)  Account for the proceeds if and when the goods are sold, or
(b)  To return the goods on demand to the consignor if they are not sold.

Why would a company engage in consignment transactions?  Consignments may increase shipment volume since consigments enable a seller to place goods on the premises of businesses that might not otherwise be able to stock them. Consignment sales increase the financing burden on the supplier since payment will not be made until the goods have been sold.  Selling on consignment is especially popular in several industries. The jewelry industry in particular is well known for selling "on memorandum," a specialized terminology meaning essentially the same thing as selling on consignment.

Technically, the consignor does not have to obtain a security interest in its merchandise as provided for under the Uniform Commercial Code. However, the consignor wishing to protect its interest against other creditors of the consignee would be well advised to follow the filing and notice requirements under Section 9-114 of the UCC. There is a disadvantage to becoming a secured creditor through the UCC because the filing process is time consuming, exacting and errors made in the filing process may result in the creditor's security interest being invalid.

In certain industries, consignment transactions are common. In most industries, consignment arrangements are extremely rare.  As a result, many credit managers know very little about the consignment process. It is important to know:

• Delivery of goods on consignment is not a sale since it does not involve the transfer of title and ownership of the consigned merchandise.
• There can be significant delays between the time the goods are delivered to the consignee and payment is issued.
• Inventory on consignment may become the subject of a secured creditor's claim [it may be seized by a secured creditor] unless the consignee has perfected a security interest in the inventory. However, there are significant costs and time required to become a secured creditor.
• A consignee may be unwilling to sign a consignment agreement, or may be prevented from doing so based on the terms of the customer's bank loan covenants.
• The "owner" or consignor is normally responsible for loss, shrinkage, or damage of its merchandise while in the control and custody of the consignee.
• The consignee does not have the same motivation to "move" the merchandise as an owner of the merchandise would. The consignee does not have as much of a vested interest in selling non-owned merchandise as it would if it owned inventory - meaning that at the end of the selling season or at the end of the consignment period the "seller" may will have to arrange for the return of unsold goods or offer the consignee additional incentives to clear the merchandise.
• In the absence of audits by the consignor, it is hard if not impossible to know that you as the consignor have been paid for all of the consigned merchandise sold by the consignee.
• Still another risk is the merchandise on consignment will be sold and the consignee will disappear with the proceeds.

Consignments are used when the financial condition of the customer is not strong meaning the buyer would not qualify for open account terms.  Consignment sales are not without risk. Credit managers faced with this opportunity/challenge need to tread lightly, and consider their moves carefully. Probably the best place to start is the consignment agreement.

Account reconciliation can be challenging under a consignment arrangement. Why? Because the consignee does not own the merchandise in question and [depending on the terms of the consignment agreement] may not necessarily be responsible for loss, damage, theft or shrinkage of or to your merchandise. When there is a discrepancy such as a shortage, the consignor often must absorb the loss.

Reprinted with the permission of Credit Research Foundation.

Edited by Michael C. Dennis.  Mr. Dennis is the author of "1001 Collection Tools and Tips."