Family Christian Stores for Bankruptcy Geeks

Warning: This post contains comments on the intersection of two subjects dear to my professional and academic heart: the Uniform Commercial Code (UCC) Article 9 and the Bankruptcy Code.

While visiting with Sarah Zylstra of Christianity Today about the larger bankruptcy law issues in the Family Christian Stores bankruptcy, we got to talking about the consignment claims of a large number of book sellers. Many of the publishers of books sold in Family Christian Stores did not sell their books to FCS but instead consigned them to FCS for sale, and that they have the contracts to prove it. Yet in its bankruptcy, Family Christian Stores takes the position that it owns the books and that the seller-consignors are merely creditors.

How can this be?

Long, long ago when I was still practicing law I took a case to the Wisconsin Supreme Court that revolved around similar facts. There I represented the general creditors of American Fuel & Supply Co. (AFSCO) who remained unpaid after AFSCO's liquidation in bankruptcy. We were suing Amoco to recover the value of motor oil that it had warehoused in AFSCO's facility, which it had removed shortly after AFSCO filed bankruptcy. I argued that Amoco was a consignor to AFSCO but that it had failed to give public notice of its consignment and should therefore lose to the unsecured creditors who knew nothing of the consignment. Even though the entire audience (my briefing associate, wife, and son) assured me I had the better of it, the Wisconsin Supreme Court disagreed and I lost 7-0. You can read the court's opinion here.

Vindication of a sort came five years later when Article 9 of the UCC was substantially revised. With the changes in the law of consignments it is now clear that my earlier argument would fail. So what, you ask? To answer that question leads to two others: What is a consignment? And how does a consignment work in bankruptcy?

Consignment is an arrangement in which the owner of goods (the consignor) entrusts the goods to an agent or bailee (the consignee) for sale. When the consignee arranges a sale of the goods, title passes directly from the consignor to the buyer, bypassing the consignee. The consignee remits a portion of the sale proceeds to the consignor and keeps the balance as a fee. Unsold goods remain the property of the consignor.

Notably, a consignee like Family Christian Stores has independently owned and operated stores. Its customers--and more importantly, its creditors--may be completely unaware that each store doesn't own what it's selling. Thus, even though consignors Abington Press, Baker Book House, David C Cook, Intervaristy Press, and many others owned books that consignee FCS was selling, it may be the case that none of the creditors of FCS knew it didn't own what was on its shelves.

Here's where it gets interesting. Article 9 of the UCC (in effect in every state in the United States) requires most--but not quite all--consignors to give public notice of their ownership interest. In other words, out of a sense of fairness to others, consignors must file a one-page document with the state so everyone who cares can see if a chain like FCS owns its inventory. Failure to file this document (known as a UCC-1 financing statement) means most consignors will lose--not to the consignee, who knows what's going on--but to the creditors of the consignee who didn't.

One of the peculiar effects of Chapter 11 bankruptcy is to turn the pre-bankruptcy debtor, who operated the business for the benefit of its shareholders, into a trustee for the benefit of its creditors. In other words, even though the pre-bankruptcy FCS knew much of its inventory was consigned, its post-bankruptcy self knows no such thing because its creditors didn't know. Didn't know, that is, unless each of the consignors filed one of those one-page financing statements. Cheap insurance, eh?

Apparently only a few of the consignors to FCS filed a financing statement. I'm not sure why the rest didn't since it typically costs only $15-50 to do so. (Did I mention it was cheap insurance?)

There is, however, one exception to the need of a consignor to file to protect itself: a consignor doesn't need to file a financing statement to protect itself if a consignee like FCS is "generally known by its creditors to be substantially engaged in the selling the goods of others." In other words, if "everybody" knows that the books on the shelves of a Family Christian Stores location don't belong to it, then the consignors get to take back their stuff.

And that's the argument the thirty-two (32!) consignors are making. Most of the creditors of FCS knew what was going on.

I didn't know that FCS was selling other people's books but I'm not a creditor, I'm not even a customer.

So, just how many of the creditors of FCS knew it was "substantially engaged in the selling of goods of others"? I have no idea but I suppose we all will know after the consignors and FCS get done litigating the matter, the costs of which will quickly hit six figures.

Did I mention that filing a financing statement was CHEAP insurance?

Those who want to know more about the intersection of the Article 9 of the UCC and bankruptcy might want to download and read my 2001 article, How Revised Article 9 Will Turn the Trustee's Strong Arm Into a Week Finger.