In re Oriental Rug Warehouse Club - 205 B.R. 407 (Bankr. D. Minn. 1997)

Rule:

Where a creditor wishes to claim a security interest in proceeds under U.C.C. § 9-306, the burden is on the party claiming the security interest to identify the proceeds.

Facts:

The Debtor, Oriental Rug Warehouse Club, Inc., was engaged in the business of selling oriental rugs and carpets at retail. In 1993, the Debtor and Yashar Rug Co., Inc. (“Yashar”) entered into "consignment agreement," whereby Debtor took possession of several of Yashar's rugs for the purpose of reselling them in its business. Debtor agreed to pay Yashar a total consignment price of $106,073.00 for the rugs, and agreed to apply the proceeds received from resale to the outstanding amount owed to Yashar. Yashar then filed a UCC-1 financing statement with the Secretary of State for the state of Minnesota to perfect its interest in the consigned rugs possessed by the Debtor. Debtor sold a portion of the consigned rugs but failed to remit the proceeds from the sales to Yashar as provided by their agreement. Subsequently, debtor filed a petition for relief under Chapter 11 of the United States Bankruptcy Code. Yashar filed a proof of secured claim in the amount of $64,243.00, representing the outstanding amount still owed to Yashar for the rugs which had been sold by the Debtor without remitting the proceeds. Pursuant to 11 U.S.C. § 502, the Debtor has objected to Yashar's secured claim, arguing that their agreement was a “true consignment” and not a “secured transaction,” and Minn. Stat. § 336.9-306 therefore did not apply. Debtor further alleged that even if it was a secured financing arrangement, Yashar cannot properly trace the Debtor's current rug inventory to the sale of Yashar's collateral as required by Minn. Stat. § 336.9-306.

Issue:

1. Was the parties’ agreement a true consignment?
2. Could Yashar’s claim be allowed, notwithstanding the fact that Yashar cannot properly trace the Debtor's current rug inventory to the sale of Yashar's collateral as required by Minn. Stat. § 336.9-306?

Answer:

1) No. 2) No.

Conclusion:

The Court noted that the determination of whether a particular transaction constituted a "true consignment" or a "secured transaction" depended on whether the parties intended to create a security interest at the time of contracting. In this case, the objective characteristics of the agreement between the Debtor and Yashar indicated that the parties did not intend to create a true consignment, but instead intended to grant Yashar a security interest in the consigned rugs. It was undisputed that the Debtor in this case: (i) has set its own prices; (ii) was billed upon shipment of the rugs and not upon sale; (iii) commingled both rugs and proceeds of rug sales with its own property; and (iv) was to receive a profit from the sale of the rugs and not a commission. Therefore, instead of creating a true consignment relationship whereby the consignee acted as agent to sell the property of the consignor, the parties to the present case created a standard "floor plan" arrangement whereby Yashar agreed to finance the Debtor's inventory in exchange for a security interest in the consigned rugs. As a secured financing arrangement, therefore, the transaction between the Debtor and Yashar was governed by the provisions of Article 9 of the UCC. In order to succeed in its claim under the UCC, Yashar must show that the debtor's current assets constituted "identifiable proceeds" arising from the disposition of its original collateral under § 9-306(2) and §§ 9-306(4)(a), and that the proceeds were properly perfected under § 9-306(3)(a). In this case, Yashar has conceded that it was impossible to reconstruct exactly what the Debtor did with the proceeds of the sale of Yashar's consigned inventory. Contrary to Yashar’s assertions, the Court held that where a creditor wished to claim a security interest in proceeds under § 9-306, the burden was on the party claiming the security interest to identify the proceeds. In this situation, Yashar should have protected itself by carefully monitoring the Debtor's inventory and by requiring the Debtor to maintain segregated accounts for the deposit of proceeds. The Court further held that Yashar was not entitled to an equitable lien against the debtor's current inventory. Minn. Stat. § 336.1-103 provided that principles of equity were applied unless displaced by particular provisions. Because Minn. Stat. 336.9-306 expressly dealt with the continuation and perfection of security interests in non-cash proceeds, Yashar could not invoke an equitable lien.