Consignment Memo - How to Perfect (00044671-2)

HOW TO PROTECT YOUR GOODS

IN BANKRUPTCY WITH CONSIGNMENTS

I. INTRODUCTION

The current financial downturn is hitting the diamond and jewelry industry particularly hard. Many retailers are paying even slower than usual and some are seeking protection in bankruptcy or liquidating their business. When a debtor refuses to return goods, files for bankruptcy or a bank forecloses on the assets of a debtor, the unsecured creditors usually lose the merchandise delivered to the debtor and accounts receivable. One way to protect the merchandise from being lost in bankruptcy or seized by the bank is to establish a legal consignment relationship. Unfortunately, many manufacturers are unaware of this or worse do not follow the proper steps for a legal consignment program.For example, the “Memorandum” form and process that the jewelry industry historically used to deliver goods DOES NOT protect aconsignor (the person that owns the merchandise),if the consignee (the person receiving the merchandise) files for bankruptcy, refuses to return the goods, etc. In order to protect and “perfect”a consignor’sinterest in goods delivered on consignment, the following is required and should be completed prior to shipping the consigned goods to consignee:

(i)consignor and consignee must sign a Consignment Agreement;

(ii)consignor must file a UCC-1 Financing Statement against consignee covering the goods to be delivered on consignment; and

(iii)consignor must send a Notice to persons or entities that previously filed a financing statement against the consignee’s inventory informing such persons or entities that consignor will be shipping goods on consignment to consignee.

II.CONSIGNMENT AGREEMENT

The Consignment Agreement will ordinarily set forth the terms of the transaction and will include verification of consignee’s corporate name, state of organization, and organization number (critical for UCC-1 filings, see below). The Consignment Agreement will also typically provide that the memo goods are delivered on consignment, title to the memo goods and proceeds[1] do not pass to the consignee without irrevocable payment of consignee’s “cost” thereof, no warranties are given by consignor, consignee is obligated to insure the goods and assumes risk of loss. Finally, the Consignment Agreement should provide the circumstances under whichconsignor or consignee may terminate the consignment agreement, consignor may demand return of the goods to consignorand other provisions to protect the consignor.

III.NOTICE

In order to perfect consignor’s “purchase money security interest” under the UCC in consigned goods, Notice must be given to other secured parties within 5 years before shipment. Consignor should conduct UCC lien searches of consignee using consignee’s full and correct legal name in the jurisdiction of consignee’s incorporation. The search will ascertain the identity of other parties who have filed a financing statement against consignee’s assets or inventory. Consignor must send a Notice to all parties with liens against consignee’s inventoryto inform them that consignor will be delivering goods on consignment to consignee.

IV.UCC-1 FILING

The filing of a UCC-1 before or within 20 days after the receipt of the consigned goods by consignee “perfects”the consignor’s security interest in such goods, and any further goods delivered on consignment by consignor to consignee pursuant to the consignment agreement, if the UCC-1 contains the following:

(i)thefull and correct

1. legal name of consignee as the “debtor” on the form (the party against whom the security interest is asserted) (our law firm confirms the corporate name from the applicable State’s data base);
2. address of the debtor’s principal office;
3. legal name of consignor as the “secured party” on the form (the party in favor of whom the security interest is asserted); and
4. address of the secured party’s principal office.

(ii)a sufficient description of the consigned goods as the “collateral” on the form (the description must reasonably identify the goods coverede.g. “all property, goods and merchandise sent or delivered to consignee on consignment, including, without limitation,assorted diamond jewelry, semi-precious stones, diamond rings, earrings and pendants and other miscellaneous jewelry and/or rings and/or semi-precious stones…”); and

(iii)filing in the proper jurisdiction, the jurisdiction of organization of consignee/debtor or, if the party is an individual, the address of such person’s domicile.

The UCC filing is generally effective for 5 years and must thereafter be renewed. Because the UCC is rendered ineffective as to future shipments if consignee changes its name, quarterly monitoring should be implemented to verify that consignee has not changed its name.

The above outline is merely a summary of some of the issues faced by the jewelry industry when considering selling goods on consignment, and is not intended as legal advice for any particular situation. For further information or to address any particular situation, please call Y. Jerry Cohen at the telephone number listed below.

{00044671.DOC; 2}

[1] Please note, however, that retailers are often restricted by their lenders from permitting consignors to have an interest in proceeds of Consignment.