Regardless of form (what the document says (e.g., “this is a lease”)), Article 9 governs any agreement that establishes a security interest.
Retention of Title
For instance, a retention of title (also known as a conditional sale) may not meet the standard requirements for a security interest, but it is also treated as a security interest. For instance, Party A transfers goods to Party B but Party A retains title of the goods until Party B has fully paid for those goods. In this instance, Party B owns the goods and Party A retains a security interest in those goods. So, a Party A needs to perfect the security interest to protect those goods against other creditors.
Regardless of how the transaction takes place, if the transaction establishes a security interest, then Article 9 governs. Sometimes a sale is framed as a lease (often called financing leases or “rent to buy” agreements). Leases are governed only by Article 2A. Whereas, if the transaction is a sale posing as a lease, Articles 2 and 9 apply.
The challenge then is to determine whether the “lease” is a true lease, or acts as a sale. To determine this, a simple test is to consider whether the seller/lessor retains possessory rights at the expiration of the lease. If the lessor gets the goods back at expiration, then the agreement was a true lease. If the lessor does not get the goods back at expiration (lessee performed), then this was a false lease (rent to buy), because the lessee was in reality a buyer. The legal test is outlined in § 1-203.
The distinction between a credit sale, sale + a security interest that appears as a lease, and a true lease is significant because of the potential impact it may have on taxes, governing law, and bankruptcy proceedings. To alleviate any concerns about what is a true lease and what creates a security interest, Article 1 § 1-203(b-e) outlines the requirements for a transaction to have a security interest rather than a lease.
To understand consignments, we also need to understand the terms “bailment” and “entrustment.” A bailment is where anyone agrees to hold goods for another person for any reason (e.g., pet sitting). An entrustment is a subcategory of a bailment where a merchant agrees to hold goods in their particular field for the entrustee (e.g., taking a ring to a jeweler for resizing). A consignment is still another subcategory of an entrustment. This is where an individual takes an item to a merchant, and the merchant is free to sell that item to another. At that point, the merchant would give the proceeds to the consignor and retain a commission from the sale.
Because consignments can be difficult to distinguish from a security interest, Article 9 establishes rules to determine whether a consignment falls under its scope. False consignments fall under the scope of Article 9 by § 9-109(a)(1). True consignments as defined by 9-102(a)(20) are governed by 9-109(a)(4) while true consignments that fall outside of the 9-102(a)(20) definition are outside the scope of Article 9.
In other words, there are three main types of consignments:
- False consignments (a security interest that looks like a consignment, governed by Article 9)
- True consignments governed by Article 9
- True consignments not governed by Article 9 (does not meet the definition outlined in 9-102(20). Essentially, low value products or consumer goods are consignments not governed by Article 9).
If Party A sells an item to Party B and Party A is obligated to buy back the item at some future time, a security interest arises in that item. This is because if Party A fails to buy back the item, then Party B will keep the desk as a security interest. However, there is a question about whether a security interest arises when Party A retains an option to back back the item. This often occurs when the value of the item is much higher than the money received.
The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.