Battle Between Prepetition Lender and Consignor Over Inventory Continues – Bankruptcy Court Holds Parties Cannot Contract to Subject Relationship to UCC

TSA Stores, Inc. v. M J Soffe, LLC (In re TSAWD Holdings, Inc.), No. 16-50364 (MFW), 2017 WL 892329 (Bankr. D. Del. Mar. 6, 2017)

Prior to the petition date, consignment vendor M J Soffe, LLC (“Soffe”) sold approximately $5.4 million of goods to the Sports Authority debtors (the “Debtors”) pursuant to a Pay by Scan Agreement.  That agreement expressly provided that the arrangement between Soffe and the Debtors qualified as a “consignment” as such term is defined in section 9-102(a)(20) of the Uniform Commercial Code (“UCC”).  During the bankruptcy proceedings the Debtors sold the Disputed Goods, and litigation arose between Soffe and the Debtors’ prepetition secured creditor, Wilmington Savings Fund Society, FSB (“WSFS”), over entitlement to the proceeds.  On one hand, WSFS asserted that it had a superior security interest in the Disputed Goods under Article 9 of the UCC because Soffe failed to properly perfect a security interest.  On the other, Soffe argued that Article 9 of the UCC was inapplicable because the facts underlying the relationship between itself and the Debtors did not satisfy the definition of a “consignment” under section 9-102(a)(20) of the UCC and, in the absence of a governing UCC, applicable state law entitled it to the superior interest.  WSFS moved for partial judgment on the pleadings, relying in part on the express language of the Pay by Scan Agreement, but the Bankruptcy Court denied its motion, finding that a disputed issue existed as to the applicability of Article 9.  According to the Bankruptcy Court, the UCC expressly permits parties to opt-out of the UCC and vary the effect of its provisions by agreement but it does not permit parties to contract around defined terms.  Parties may limit their legal relationship but such limitations are not without their boundaries.  Changing the UCC’s definitions – i.e. changing the meaning of the statute’s terms – is only appropriate for legislatures.  And while WSFS argued that Soffe’s arguments should be estopped and that the Court’s holding would render the Pay by Scan Agreement’s UCC provision superfluous and thus, inconsistent with contractual interpretation canons, the Court was not persuaded, noting that it cannot enforce a contractual term inconsistent with or prohibited by the UCC.