Bulk-sales--Article 6 of the uniform commercial code

Abstract

Receiving a bulk sales notice typically sends shivers up the spine of trade creditors. However, those shivers would be welcome now that most states have authorized debtors to transfer their assets with absolutely no warning or notice to its trade creditors. As a result, a great burden and increase in financial exposure have been imposed on trade creditors who sell inventory to debtors in those states that have repealed Article 6 (BULK Transfers) of the Uniform Commercial Code (the "UCC"). In such states, a debtor selling its inventory pursuant to a bulk sale does not have to provide a notice of such bulk sale to any of its trade creditors. Absent fraud, trade creditors will have no recourse against the purchaser or the transferred inventory. Accordingly, trade creditors may face financial losses and have an almost impossible burden to constantly monitor the business operations and transactions of a debtor.

This article analyzes the reasoning behind the change in notice requirements for bulk sales, the history of bulk transfer laws, Article 6 of the UCC and each state's position with respect to Article 6 of the UCC.

History of Bulk Transfer Laws.

Bulk transfer laws are unique to North American jurisprudence and have never been enacted in Great Britain. They were first enacted in the United States and Canada around the turn of the century at the behest of unsecured trade creditors.

Before the enactment of bulk sales laws, certain merchants would set up shop in a town, operate for a period of time, sell the merchandise in bulk and depart with the proceeds, leaving creditors unpaid. This activity was particularly prevalent during the periodic economic downturns of the times, especially during the mid-1890's. Not only did primitive communications, banking and transportation systems of the day make it difficult for creditors to keep careful track of these "tramp" merchants, but the lack of common-law remedies made it difficult for creditors to recoup their losses. It was common for a supplier to visit the merchant only a few times a year, depending on the distances to be traveled. Thus, it was not terribly difficult for a merchant to engage in a bulk sale and skip town undetected with proceeds in hand, perhaps setting up shop elsewhere unbeknownst to the merchant's creditors.

The creditors had a right to sue the merchant on the unpaid debts, but that right often was of little practical value. Even those creditors who succeeded in obtaining a judgment often were unable to satisfy it because the defrauding merchant had spent or hidden the sale proceeds. In addition, the creditors ordinarily did not have recourse to the merchandise sold. The transfer of the inventory to an innocent purchaser effectively immunized the goods from reach of the merchant's creditors. The creditors of a bulk transfer merchant thus might be left without a means to satisfy their claims.

Faced with this situation, an association of credit managers, the National Association of Credit Men, engaged in an intense lobbying effort for the enactment of federal bankruptcy laws and for the enactment of bulk sales laws throughout the United States. By 1909, every state had enacted bulk sales laws. However, these laws were not uniform. As a result, the enactment effort turned toward accomplishing uniformity. To a large degree, uniformity was achieved with the promulgation of Article 6 of the UCC.

Article 6 (1987 Official Text) of the UCC.

Article 6 (1987 Official Text) of the UCC ("Original Article 6") places a burden on purchasers in bulk from certain specified businesses to notify creditors of the seller in writing 10 days before the purchaser receives delivery of the goods or pays for them, and to maintain a list of the seller's creditors and a schedule of property obtained in a bulk sale for 6 months after the bulk sale takes place. During this 10-day period, a trade creditor may be able to stop the bulk sale by either (I) filing an involuntary bankruptcy petition against the seller (this remedy requires a joining of three creditors of the seller with an aggregate outstanding balance in excess of $10,000), or (II) obtaining a court ordered injunction enjoining the closing of the bulk sale transaction.

In the event the purchaser fails to comply with Original Article 6, the bulk sale transaction may be voidable by those creditors of the seller, which relate to the noncompliance. As an example, in the event a trade creditor was not set forth in the seller's list of creditors and did not receive a notice of the bulk sale, such creditor may disregard the transfer to the purchaser and levy on the goods as though they still belong to the seller (even though legal title and possession of the goods have passed to the purchaser) in order to satisfy the debt due from the seller. A net effect of failure to comply is that the purchaser may have to pay more than once for the goods purchased in bulk.

Opposition to Original Article 6.

Original Article 6 has been subjected to serious criticism. The opponents to the continuation of Original Article 6 state that the credit environment has changed so that the risk of the absconding merchandiser is no longer very great. Changes in technology have enabled credit-reporting services to provide fast, accurate, and more complete credit histories. In addition, statutes and laws have greatly improved the possibility of commencing a legal proceeding against a merchant who flees to another state. Accordingly, the opponents to Original Article 6 state that business creditors can evaluate credit worthiness far better than was the case when the UCC was first promulgated and they can pursue absconding sellers with much less difficulty.

The opponent's further state that creditors no longer face the choice of extending unsecured credit or no credit at all. Article 9 of the UCC makes the extension of credit on a secured basis more certain and easy to accomplish. Inventory financing under Article 9 of the UCC provides more significant protections for creditors, thus bypassing Original Article 6 protections. In addition, to the extent a bulk sale is fraudulent and the purchaser is a party to the fraud, creditors have remedies under the Uniform Fraudulent Transfer Act (or the Uniform Fraudulent Conveyance Act) which has been adopted in many states. These sorts of criticisms led to a study of Original Article 6 by a subcommittee of the American Bar Association to determine if it could be improved. That group included both opponents of complete repeal of Original Article 6 and proponents who instead stressed strengthening Original Article 6. The report of the subcommittee reflected a compromise between the two factions, which favored corrections of the technical difficulties of Original Article 6.

The drafting committee of the National Conference of Commissioners on Uniform State Laws ("NCCUSL") was appointed to begin the task of revising Original Article 6. The drafting committee maintained a position, almost to the end of the drafting process that the repeal of Original Article 6 was not feasible. NCCUSL's approach was to take a form of Original Article 6 as a given, and attempt to reduce the compliance burdens it imposes while at the same time improving the protection of the statute for the seller's creditors that are its beneficiaries. This approach however was reversed and the NCCUSL recommended to states as its preferred position, the repeal of Original Article 6. In support of that recommendation, the perception of the NCCUSL was that changed business and legal conditions since the original bulk transfer laws were enacted made them essentially unnecessary. The conclusion then reached was that any benefit to creditors from these laws was so minimal that it could no longer justify the costs of interfering with good faith transactions. In addition, there was strong sentiment that the liability that could be incurred due to inadvertent noncompliance by a good faith purchaser for full value without notice of any wrongdoing on the part of the bulk seller was unwarranted. Two alternatives have been recommended to the states relative to bulk transfer laws.

Alternative A.

The American Law Institute agreed with the position of the NCCUSL in its action on the revision of Original Article 6, and the recommendation for repeal became Alternative A of Revised Article 6 ("Alternative A"). Accordingly, a state, which enacts Alternative A repeals Original Article 6 and does not replace it, and repeals or amends related provisions of the UCC. The net effect of Alternative A is that a merchant can transfer its inventory in bulk with absolutely no notice to its trade creditors. In the event of a bulk sale, trade creditors will have no recourse against the purchaser or the transferred inventory except in the case of fraud.

Alternative B.

While enactment of Alternative A is a recommended course, the NCCUSL and the American Law Institute also promulgated a revised Article 6 which became Alternative B of Revised Article 6 ("Alternative B"). Alternative B repeals Original Article 6 and replaces it with a considerably revised version that affords better protection to the seller's creditors (as compared to Alternative A which repeals Original Article 6) but not nearly as much protection as afforded under Original Article 6. Alternative B also intended to minimize the delay, risk and cost of compliance for bulk sale purchasers.

The pertinent provisions of Alternative B are as follows:

(a) A "bulk sale" takes place if there is a sale of "more than half the seller's inventory outside the ordinary course of business and under conditions in which the "buyer has notice...that the seller will not continue to operate the same or a similar kind of business after the sale".

Note: Original Article 6 states that a bulk transfer is a transfer of a major part of the materials, supplies, merchandise or other inventory. It is unsettled whether a "major part " is more than 50% and whether a "major part " is based on quantity or value.

(b) Alternative B excepts any asset sales that fall below a value of $10,000 (net of liens and security interests) or that exceed a value of $25 million. Note: There are no dollar limit exceptions under Original Article 6.

(c) The choice of law provisions of Alternative B limits the applicable law to that of one jurisdiction.

(d) If the seller provides a list of 200 or more claimants, or provides a verified statement that there are more than 200 claimants, the purchaser satisfies the notice requirements under Alternative B by filing a written notice of the "bulk sale" with the office of the Secretary of State (or other applicable official, as a state provides) rather than by giving written notice to all claimants. Note. Under Original Article 6, the purchaser obtains a list of creditors and provides each of them with notice of the "bulk sale ".

(e) The purchaser shall give notice of the bulk sale not less than 45 days before the date of the bulk sale.

Note. Under Original Article 6, the purchaser must give notice at least 10 days before the purchaser takes possession of the goods or pays for them.

(f) The seller and purchaser must agree on the net contract price to be distributed and then must set forth "a written schedule of distribution". The "schedule of distribution" may provide for any distribution that the seller and the purchaser agree to, "including distribution of the entire net contract price to the seller". The "schedule of distribution" accompanies any notice given to claimants in accordance with Alternative B.

Note. Alternative B provides for a different array of information that is kept for creditors. Under Original Article 6, the purchaser must keep a schedule of property and a list of claimants for a 6month period following the sale. The foregoing are not requirements under Alternative B.

(g) The remedy for creditors under Revised Article 6 provides for money damages. A creditor is entitled to damages for noncompliance against the purchaser and the seller in an amount equal to such creditor's real losses. There are limits on the damages that may be assessed.

Note. Under Original Article 6, the main sanction for noncompliance is that the transfer will be ineffective against those creditors of the seller, which relate to the noncompliance. Such creditors may disregard the transfer to the purchaser and levy on the goods as though they still belong to the seller even though title and possession have passed to the purchaser.

(h) Generally, any action commenced by a creditor under Alternative B must be commenced within one year after the bulk sale.

Note: Under Original Article 6, an action must be commenced within 6 months after the bulk sale.

Conclusion.

Thirty-five states and Puerto Rico have adopted Alternative A and have repealed Article 6 in its entirety. Creditors shipping inventory to vendors in those states will receive no notice of a bulk sale. Alternative B which has been adopted by 5 states and the District of Columbia affords more protection than Alternative A but considerably less protection than Original Article 6.

In light of Alternative A and Alternative B which have been adopted by 40 states, the District of Columbia and Puerto Rico, creditors should take greater measures to keep abreast of the transactions and operations of their merchants in order to minimize the risks associated with a bulk sale of such merchant's inventory.

Copyright - 1998 Lawrence C. Gottlieb, Esq. and Robert A. Boghosian, Esq. Kronish, Lieb, Weiner, & Hellman, LLP, 1114 Avenue of the America's, New York, NY 10036 Phone: (212) 479-6140

Copyright Credit Research Foundation Third Quarter 1998
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