Warning: Deep inside
commercial finance baseball.
Drop shipping, for those
not in the business of wholesale distribution, is the term applied when a
middleman (typically a wholesaler) buys goods from a manufacturer and has them
delivered directly to a retailer. In other words, the wholesaler buys but never
takes physical possession of the goods. Wholesalers do this for two reasons: it
saves them the cost of (re)delivery and they typically require payment from
their retailer before their payment is due to the manufacturer. Playing that
margin of perhaps 30 days can add up to measurable interest when we're talking
about sales of millions of dollars of goods.
But what if the
wholesaler files bankruptcy between the time the manufacturer "drops"
the goods on the retailer but before the manufacturer has been paid? Does such a
manufacturer simply find itself in the pool of all other unsecured creditors,
getting perhaps 10 cents on the dollar (if it's lucky)? Or does it have the
power to reclaim the goods themselves?
Congress, in its search
to advance the common good, wanted to protect manufacturers (and other sellers)
generally and so granted sellers who deliver goods to a buyer within 20 days of
the bankruptcy filing a limited "priority" over other unsecured
creditors. But what if the goods are delivered within the 20-day window but to
the wholesaler's retailing buyer, not the wholesaler itself? SOL, per the
bankruptcy court in Delaware. The Bankruptcy Code's priority provision speaks
in terms of delivery to the buyer-debtor and so doesn't protect the manufacturer
who innocently agrees to drop ship directly to the retailer. Read all about it
in Bill Rochelle's piece here.
In addition to
Bankruptcy, I regularly teach Secured Transactions. And, as I regularly explain to students in both courses, there's a much better way for a seller to protect
itself from the risk of a bankrupt buyer: retain a purchase-money security interest.
I won't bore folks with
the technicalities of a PMSI except to raise one question: Does a seller get
the benefit of the extra 20-day window in which to perfect when goods are drop
shipped? Pre-shipment perfection plus a subordination agreement from the holder of a conflicting security interest will always work but
sometimes in the flurry of business activity the seller doesn't get around to
perfecting (much less getting a senior secured creditor to subordinate) until some
point post-shipment.
Here's the relevant text
of UCC 9-317(e):
[I]f a person files a financing statement with respect to a purchase-money security interest before or within 20 days after the debtor receives delivery of the collateral, the security interest takes priority over the rights of a buyer, lessee, or lien creditor which arise between the time the security interest attaches and the time of filing.
You'd think--or at least
I'd think--that the intersection of delayed perfection and drop shipments would
be resolved in the text of the statue, its Official Comments, or the case law.
If this question has been answered, I can't find it.
If I can go out on a
limb and predict what I think most courts would answer it would be like what we
see in connection with the bankruptcy priority: "delivery" to a
debtor means physical delivery to the wholesale debtor, not to a retail buyer from the debtor. I'm
not sure this makes any sense from the perspective of the policy of Art. 9 (or
bankruptcy law for that matter) but that's my bet for now.
(For my earlier discussion of a similar topic--consignments--in connection with the first bankruptcy of Family Christian Stores go here. If you're interested in an overview of this area of the law, you can read my article, How Revised Article 9 Will Turn the Trustee's Strong Arm into a Weak Finger that can be downloaded here or here.)
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