United States: Proof That Consigned Goods Are Property Of The Estate Is Required Prior To A §363 Sale

The U.S. Bankruptcy Court for the District of Delaware recently considered whether consigned goods may be sold pursuant to section 363(f) of the Bankruptcy Code. In analyzing what the court described as "an issue of great importance," the court held that consigned goods may not be sold absent evidence proving that such goods constitute property of the estate. In re Whitehall Jewelers Holdings, Inc., 2008 WL 2951974 (Bankr. D. Del. Jul. 28, 2008).

In Whitehall, the debtors sought relief from the bankruptcy court approving the sale of certain assets free and clear of all creditors' interests in the assets. These assets included inventory, a significant portion of which was comprised of consigned goods. The debtors argued that there existed a bona fide dispute concerning the debtors' and consignors' interests in the consigned goods.

Under certain circumstances, section 363 permits the sale of estate property free and clear of any interest in such property of an entity, other than the estate. One such circumstance exists when the interest asserted is in "bona fide dispute." However, no property may be sold pursuant to section 363 unless such property first is determined to be property of the estate.

The bankruptcy court determined that the debtors failed to address the preliminary issue of whether the consigned goods constituted property of the estate. Although the term "property of the estate" is inclusive and broadly defined, when seeking to sell property pursuant to section 363, a debtor bears the burden of proving that the property is, in fact, property of the estate. The court found that the debtors failed to meet their burden of proof with respect to this issue, and that the evidence was insufficient to conclude that the consigned goods were property of the estate.

The relationships between the debtors and the various consignors in Whitehall were governed by agreements that provided that a consignor of goods would remain the owner of the consigned merchandise, and that the debtors would "acquire no right, title or interest in the Consigned Merchandise other than the right to possess the Consigned Merchandise as a consignee and sell the Consigned Merchandise as provided under the Terms of Consignment." These agreements further provided that the consigned goods were sold to the Debtors on a "sale or return basis."

The court found that the agreements could support an inference that the consignors held an ownership interest in the property; thus, there existed the possibility that the consigned goods were not estate property. Based on the evidence available, the court refused to conclude that the consigned goods constituted estate property. Accordingly, since the debtors had not proved that the consigned goods were property of the estate, they could not be sold pursuant to a sale in accordance with section 363 of the Bankruptcy Code.

The court also noted that, consistent with Third Circuit precedent, an adversary proceeding is the only available means by which to determine the validity, priority or extent of an interest in property. Thus, a contested matter such as a motion to sell property under section 363 is not the proper procedural means by which to extinguish a creditor's interest in property.

The court's opinion emphasizes that prior to determining whether a debtor may sell property free and clear of all interests of entities other than the estate, a debtor first must prove that the property it seeks to sell constitutes estate property. Failure of a debtor to adduce evidence affirmatively proving that the property it seeks to sell is estate property will result in the refusal of courts to permit the sale.

In this case, the debtor did not meet the threshold issue of proving that the consigned goods were estate property. This issue is separate and apart from whether there is a conflict of interest with respect to the property. Because the debtor did not meet the threshold issue, the court did not consider whether the property could be sold. It seems likely, however, that there would be a bona fide dispute (under the facts of the case) that would permit a sale under section 363.

Creditors objecting to a motion for the sale of assets pursuant to section 363 should consider whether the debtor has met its burden of proving the threshold issue that the property it seeks to sell is, in fact, estate property.

This article is presented for informational purposes only and is not intended to constitute legal advice.