Protecting Your Rights in a Consignment Sales Agreement

Perfecting a security interest requires filing a UCC-1 financing statement with the appropriate state office, typically the New York Department of State for goods held by a consignee in New York. The filing must identify both the consignor (as secured party) and the consignee (as debtor) with sufficient accuracy to allow a search under the UCC search logic. A consignor who fails to file loses priority to the consignee's other creditors and to a bankruptcy trustee. In practice, many consignors assume that the consignment agreement alone protects their ownership; it does not. The filing is the legal mechanism that makes ownership enforceable against third parties.

In New York, a consignor with a perfected security interest may pursue replevin (recovery of the goods themselves) or damages for conversion. New York's Uniform Commercial Code section 9-609 permits a secured party to repossess collateral without judicial process if it can do so without breach of the peace. If the consignee refuses to return goods or if the goods have been sold without payment, the consignor may file suit in New York Supreme Court (the trial-level court in New York County and other counties) or in a lower court depending on the amount in dispute. The court will examine whether the consignment agreement was properly executed, whether the consignor had a perfected security interest, and whether the consignee's actions constitute conversion or breach of contract. Real-world outcomes depend heavily on whether the consignor documented its ownership claim from the start.

If the consignor is paid only after the consignee receives payment from the end customer, the consignor bears the credit risk of the consignee's customers. If payment is due weekly or monthly regardless of whether the consignee has sold the goods, the consignor shifts risk to the consignee. Many agreements use a hybrid: the consignee pays for goods sold within 30 days, but unsold inventory remains the consignor's responsibility. The agreement must also address what happens if the consignee's customer disputes the sale or returns the goods. Does the consignee have the right to return unsold goods to the consignor? Under what conditions? Without clear terms, disputes over inventory reconciliation and payment withholding become protracted and expensive.

Consignors should require periodic accounting statements (at minimum monthly) detailing which goods were sold, to whom, and when payment was received. The agreement should grant the consignor the right to audit the consignee's records and conduct physical inventory inspections. In New York commercial disputes, courts often examine whether the consignor exercised reasonable oversight; failure to audit can weaken a consignor's position if the consignee later claims goods were lost or damaged. As counsel, I often advise consignors to establish a clear audit schedule in writing and to document each inspection. This creates a paper trail and signals to the consignee that accountability is expected.

Most consignment agreements place risk of loss on the consignee after the goods are delivered and before the end customer takes possession. The consignee should maintain insurance covering the consignor's goods. The agreement should require the consignee to name the consignor as an additional insured or loss payee on the policy. Without this, if goods are damaged or destroyed, the consignor may have no recovery against the consignee's insurer. The consignor should also require proof of insurance before goods are delivered and should verify that coverage remains active throughout the consignment period.

The consignee should indemnify the consignor against claims arising from the consignee's sale or handling of the goods. For example, if the end customer is injured by a defective product and sues both the consignee and the consignor, the consignee's indemnity should require the consignee to defend and pay the consignor's defense costs. This allocation is critical because product liability exposure can be substantial. New York courts enforce indemnity clauses but require them to be clear and unambiguous; vague language may be construed against the drafting party. The consignor should also clarify that indemnity applies to claims arising from the consignee's negligence or breach, not to claims arising solely from the product's inherent defect (which may be the consignor's responsibility).

The agreement should allow either party to terminate on written notice, typically 30 to 60 days. Upon termination, the consignee must return all unsold goods to the consignor in the same condition as received, ordinary wear excepted. The consignor should have the right to inspect goods upon return and to document any damage. If the consignee refuses to return goods or claims they were lost, the consignor's recourse depends on whether it has a perfected security interest (discussed earlier) and whether it can prove the consignee's breach. A consignment sales agreement should include a detailed return procedure: the consignee must segregate unsold goods, provide an inventory list, and allow the consignor to collect within a specified timeframe.

If the consignee enters bankruptcy, the consignor's claim to the goods depends on the perfection of its security interest. A perfected consignor is treated as a secured creditor and has priority over the bankruptcy estate and unsecured creditors. An unperfected consignor is treated as an unsecured creditor and may recover little or nothing. The consignor should also be aware that a bankruptcy trustee may challenge the consignment arrangement as a disguised secured transaction if the consignor has not complied with UCC filing requirements. Consignors should review the consignment agreement terms annually and verify that financing statements remain on file and are renewed before they lapse (typically every five years in New York).

Consignment sales agreements are powerful tools for managing inventory and expanding distribution channels, but they require careful drafting and disciplined execution. The most common pitfall is assuming that the agreement alone protects the consignor's ownership; it does not. Perfecting a security interest, maintaining clear accounting, requiring adequate insurance, and establishing a termination protocol are the legal mechanisms that make the arrangement enforceable. Decision-makers should review existing consignment agreements now to identify gaps, ensure UCC filings are current, and clarify payment and return procedures. If a dispute arises or if a consignee faces insolvency, the quality of the original agreement and the consignor's diligence in perfecting and monitoring the arrangement will determine whether the consignor recovers its goods or becomes an unsecured creditor in a lengthy and uncertain process.