In Fariba v. Dealer Services Corp., 2009 WL 3191538 (2009), the California Court of Appeal for the Fourth District held that a floorplan lender’s security interest was subordinate to an automobile wholesaler’s ownership interest because, under consignment law, the floorplan lender knew that the defunct dealer dealt in consignment sales.  The facts were as follows:

Plaintiff Behyar Fariba is an automobile wholesaler. California Auto Sales & Leasing (CASL), which is not a party to this action, was an independent retail automobile dealer to which Fariba provided vehicles on a consignment basis. Defendant Dealer Services Corporation (DSC) is a finance company that financed CASL’s inventory under a written promissory note and had a perfected security interest in, among other things, CASL’s inventory of vehicles.  ¶  When CASL went out of business and Fariba attempted to retrieve his vehicles, he discovered 14 of his vehicles were being repossessed by DSC. When DSC refused to return the vehicles, Fariba sued. At trial, the court dismissed Fariba’s fraud and breach of contract causes of action, as well as his claim for punitive damages. The case went to the jury solely on the issue of who-Fariba or DSC-had priority under the California Uniform Commercial Code as to the vehicles.

The Court found that Fariba, the wholesaler, had priority over the floorplan lender’s security interest, explaining:

Case law defines a consignment sale as “one in which the merchant takes possession of goods and holds them for sale with the obligation to pay the owner of the goods from the proceeds of a sale by the merchant. If the merchant does not sell the goods the merchant may return the goods to the owner without obligation. [Citation.] In a consignment sale transaction, title to the goods generally remains with the original owner.” (Bank of Cal. v. Thornton-Blue Pacific, Inc. (1997) 53 Cal.App.4th 841, 847) ¶  To analyze Fariba’s rights, we turn to section 9319, which sets forth guidelines for determining the rights of consignees with respect to creditors of the consignee:


“(a) Except as otherwise provided in subdivision (b), for purposes of determining the rights of creditors of, and purchasers for value of goods from, a consignee, while the goods are in the possession of the consignee, the consignee is deemed to have rights and title to the goods identical to those the consignor had or had power to transfer. [¶] (b) For purposes of determining the rights of a creditor of a consignee, law other than this division determines the rights and title of a consignee while goods are in the consignee’s possession if, under this chapter, a perfected security interest held by the consignor would have priority over the rights of the creditor.” (Italics added.)


The official comments to section 9319, subdivision (a) state:


“[F]or purposes of determining the rights of certain third parties, the consignee is deemed to acquire all rights and title that the consignor had, if the consignor’s security interest is unperfected. The consignee acquires these rights even though, as between the parties, it purchases a limited interest in the goods (as would be the case in a true consignment, under which the consignee acquires only the interest of a bailee). As a consequence of this section, creditors of the consignee can acquire judicial liens and security interests in the goods.” (Official Comments on U. Com.Code, West’s Ann. Cal. U. Comm. Code (2002 ed.) foll. 9319, p. 364, italics added.)


However, section 9102, subdivision (a)(20)(A)(iii) provides a transaction is not deemed a consignment subjecting the consignor’s goods to the claims of the consignee’s creditors if the consignee is “generally known” by its creditors to be substantially engaged in selling the goods of others:


“(20) ‘Consignment’ means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and all of the following conditions are satisfied. [¶] (A) The merchant satisfies all of the following conditions: [¶] (i) He or she deals in goods of that kind under a name other than the name of the person making delivery. [¶] (ii) He or she is not an auctioneer. [¶] (iii) He or she is not generally known by its creditors to be substantially engaged in selling the goods of others.” (Italics added.)


Thus, “[a] consignor may prevent the application of … [Uniform Commercial Code ( UCC) ]  §§ 9-102(a)(20) & 9-319(a) if it qualifies for one of the two exceptions provided under California law. [Citations.] … The consignor must either have (1) filed a UCC-1 financing statement as required under [UCC] Article 9 or (2) prove that the deliveree is generally known by his creditors to be substantially engaged in selling the goods of others. [Citations.] If either of these notice requirements of [UCC] Article 2 are met, then [UCC] … §§ 9-102(a)(20) & 9-319(a) will not apply and the consignee’s creditors may not reach the consigned goods in the consignee’s possession.” (In re Valley Media, Inc. (Bankr. D. De. 2002) 279 B.R. 105, 123 [applying California law], fn. omitted.)


Here, however, Fariba did not attempt to prove at trial that it was “generally known” by CASL’s creditors that it was substantially engaged in selling the goods of others. Rather, Fariba sought to prove, and the jury found, that DSC had actual knowledge CASL was substantially engaged in selling the property of others. Thus, we are presented with an issue of first impression in California: Does actual knowledge by a creditor with a perfected security interest in the inventory of a business that the business was substantially engaged in selling goods of others, i.e., selling goods on a consignment basis, defeat the right of that creditor in the consigned goods? We hold that it does, and the court therefore did not err in instructing the jury on the question of DSC’s actual knowledge.