Magazine article Business Credit

Bailment versus Sale: Another View

Magazine article Business Credit

Bailment versus Sale: Another View

Article excerpt

Solid manufacturers often find that a financially troubled supplier cannot be abandoned especially when the troubled supplier is a sole source supplier or has the quality or the expertise the manufacturer requires.

In the November/December issue of Business Credit, my colleague Bruce Nathan discussed the Citation Corporation case in which a bankruptcy court in Alabama found that AVCO Corporation, a manufacturer of airplane engines had purchased and supplied steel to Citation, a manufacturer of airplane crankshafts. AVCO and Citation executed an agreement titled "Consignment Agreement." AVCO purchased the steel and had it shipped to Citation. In turn, Citation used the steel to manufacture the crankshafts for AVCO. AVCO did not file a Uniform Commercial Code financing statement for the steel. After Citation filed bankruptcy, the bankruptcy court held that the relationship was not consignor/consignee but rather a common law bailment. Thus, AVCO had the right to pick up its steel, which had never become the property of Citation and therefore, never become the collateral of Citation's lender.

Not all courts will interpret this common situation as the Citation court did. A bankruptcy court and the Sixth Circuit Court of Appeals in GMAC Business Credit v. Ford Motor Company, et al. interpreted a similar situation and found that the purchaser of raw materials for the troubled supplier, H.S.A., did not have a bailment and therefore had to pay twice for the raw materials if it wanted it back, or wanted either the unfinished work in process or finished parts. Ford, the purchaser of the steel who hoped to help its manufacturer through troubled times and to continue the flow of parts so that manufacturing could continue, ended up the loser by having to pay twice for its parts.

This situation is frequent in the troubled automotive supply industry where stopping the production of any original equipment manufacturer will cause enormous consequential damages to the supplier. Customers seeking to assist a troubled supplier should consider discussing the problem with the supplier and involve the supplier's lender prior to purchasing the raw materials for the customer.

Common Law Bailment

A bailment is recognized by common law generally as a delivery of personal property by the property's owner, known as the bailor, to a bailee for a particular purpose. When this purpose is fulfilled, the bailee is then required, by express or implied contract, to redeliver those goods to the bailor. A bailment is distinguished from a sale because there is no passage of title to the personal property; the bailee is estopped from denying that the bailor holds title. The bailor has the right to instruct the bailee as to how to dispose of the property and correspondingly, a bailee will be liable for conversion in the event he fails to re-deliver the goods to the bailor as directed once the purpose of the bailment is completed.

Troubled Processor

Occasionally, a supplier may be unable to continue production of parts for its customers without additional financing and is unable to secure that financing from its existing bank lender. In the absence of this financing from existing or new sources, customers facing an imminent collapse of their supplier may purchase raw material inventory on the supplier's behalf and arrange for delivery of those goods to the supplier for fabrication into needed parts. Upon production and delivery of finished parts, the customer will then pay the supplier for the costs of manufacturing, having already absorbed the cost of the necessary raw materials. This arrangement is often memorialized by a bailment agreement between the customer and the supplier in which the supplier recognizes that it holds no interest in the inventory other than mere possession, as title to the inventory is held by the customer throughout the manufacturing process. What happens, however, if the supplier becomes a debtor in a Chapter 11 case and the secured lender holding a lien on all the debtor's inventory claims that its lien is superior to the rights of the customer and purchaser of the raw materials needed for the manufacturing process? …

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