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The Bulk Sale Statute--Still Alive And Kicking.

Prior to 1990, Article 6 of the Uniform Commercial Code (UCC) was the uniform state law that regulated bulk sales. UCC Article 6 was enacted to deal with a fraud that was common at the turn of the 20th century. A merchant would acquire inventory on credit and then in a "bulk sale" sell all or a large part of its inventory to a single buyer outside the ordinary course of business and then disappear with all of the sales proceeds leaving creditors high and dry.

Who could the seller's creditors sue for payment of their claims? Creditors could sue the seller but their judgments were often uncollectible because they could not locate the seller who had either dissipated or secreted the sales proceeds. The buyer was not responsible to the seller's creditors unless the buyer had agreed to pay their claims. Creditors were left with no claim against the buyer or the transferred assets unless they could prove that the transaction was a fraudulent conveyance.

Original UCC Article 6 applied to bulk transfers of a major part of the materials, supplies, merchandise and other inventory outside the ordinary course of the transferor's business. It required a bulk sale transferee to give notice of the transfer to the transferor's creditors and maintain a list of the transferor's creditors and the property transferred and in some states, to distribute the sales proceeds to the transferor's creditors. In the event the transferee failed to follow all of the requirements of original UCC Article 6, the transferor's creditors had recourse to the assets the transferee had acquired.

Compliance with original UCC Article 6 became extremely burdensome, especially if the transferor had many creditors. The transferee risked becoming a quasi-guarantor of payment of the claims of the transferor's creditors and, therefore, subjected to unanticipated liability. This discouraged legitimate bulk transfers, limited the number of prospective transferees who were willing to acquire a troubled company's assets in a bulk transfer and depressed the price that a troubled seller could realize for its assets.

Original UCC Article 6 also became outmoded. The risk of a transferee running off with the bulk sale proceeds leaving creditors high and dry has been greatly reduced. Improved credit reporting has enabled creditors to evaluate the creditworthiness of a prospective customer, allowing them to make more informed credit decisions. Creditors also have less difficulty suing and recovering from the transferor. And if the bulk transfer is a fraudulent conveyance, the transferor's creditors have a remedy under state law and the Bankruptcy Code. It is also easier for creditors to file an involuntary bankruptcy petition against the seller to either stop an improper bulk transfer or to investigate and pursue fraudulent conveyance and other avoidance type claims.

In view of the substantial cost of compliance with original UCC Article 6, including delays in closing legitimate business deals, and the alternative protections available to creditors outside of original UCC Article 6, it became apparent that the costs outweighed the benefits of continuing to operate under original UCC Article 6. This led the American Law Institute (All) and the National Conference of Commissioners on Uniform State Laws (NCCUSL), the entities responsible for studying, proposing revisions to and drafting various provisions of the UCC, to conclude that original UCC Article 6 was no longer useful. The All and NCCUSL recommended as their first choice that the states repeal original UCC Article 6. The ALL and NCCUSL had a fallback position, a substantially revised version of UCC Article 6, for those states that refuse to repeal Article 6, which protects creditors but removes some of the burdensome compliance requirements of original UCC Article 6.

Unfortunately, this has not led to uniformity among the states. While most states have repealed UCC Article 6,Arizona, California, Indiana, Virginia and the District of Columbia have adopted Revised Article 6, and the remaining states have retained original UCC Article 6.This lack of uniformity among the states and the need to determine which state law applies to a bulk sale has caused confusion and requires creditors and purchasers in bulk sale transactions to be especially diligent about the manner in which the original and revised versions of UCC Article 6 regulate bulk sales.

States Repealing UCC Article 6

As of April, 2000, 38 states and Puerto Rico have repealed UCC Article 6. They include Alabama, Alaska, Arkansas, Colorado, Connecticut, Delaware, Florida, Hawaii, Idaho, Illinois, Iowa, Kansas, Kentucky, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Mississippi, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Dakota, Tennessee, Texas, Utah, Vermont, Washington, West Virginia and Wyoming. Legislation to repeal UCC Article 6 has also been introduced in Maryland, Rhode Island, Wisconsin and the U.S. Virgin Islands. States that have repealed UCC Article 6 have not left creditors defenseless. Creditors may seek to enjoin a bulk transfer or sue to avoid the transfer as a fraudulent conveyance. Creditors may also join in filing an involuntary bankruptcy petition against the transferor to stop the bulk transfer or have the bankruptcy trustee investigate and prosecute fraudulent conveyance and other avoidance claims.

States Retaining Original UCC Article 6

Seven states, including Georgia, Maryland, Missouri, New York, North Carolina, Rhode Island and South Carolina continue to follow original UCC Article 6. It defines a "bulk transfer" as any transfer in bulk and not in the ordinary course of the transferor's business of a major part of the materials, supplies, merchandise or other inventory where the transferor's principal business is the sale of merchandise from stock. This definition has caused confusion. First, the precise meaning of the term "not in the ordinary course of the transferor's business" is unclear. Is a routine sale of end of season or excess merchandise a bulk transfer where the sale is part of a closeout sale of all of the transferor's assets on the eve of bankruptcy? Maybe the cases go both ways. There is a general consensus that the term, a "major part" of inventory means more than one half of the value of the transferor's inventory. Does this require considering all of the transferor's inventory, regardless of location and timing of sale?

Original UCC Article 6 also applies primarily to merchants and manufacturers of goods. Many courts have excluded restaurants and other food dispensing businesses, hotels, cleaning establishments, barber shops and pool halls from bulk sales regulation because they provide services and do not sell goods.

However, some states, like New York, have expanded the categories of businesses covered by original UCC Article 6 to include restaurants and other food dispensing businesses.

Original UCC Article 6 imposes certain duties on a bulk sale transferee. The transferee must give advance notice of the sale and make certain information about the transfer available to the transferor's creditors. The transferee must obtain a list of the transferor's existing creditors. This list must contain the names, addresses and the amounts of the claims of the transferor's creditors and must be signed and sworn to by the transferor. The transferee must also obtain a list of the assets being sold by the transferor. The transferee must then preserve both lists for six months after the transfer and permit any creditor to inspect and copy the lists and either permit reasonable access to the lists, or in some states file them in the appropriate public office. The transferee's failure to satisfy all of these requirements enables the transferor's creditors to levy upon the assets acquired by the transferee as if the sale were a nullity.

The crucial part of original UCC Article 6 is the notice requirement. The transferee must give advance notice of the transfer to all of the transferor's creditors on the creditors list and all of the transferor's other creditors known to the transferee. The notice must be given not later than 10 days before the transferee takes possession of or pays for the goods and must be delivered by hand or by registered or certified mail. Because the 10-day period starts to run from the date of mailing of the notice, the transferor's creditors are given precious little time to investigate the transaction. In fact, it is not uncommon for the transferor's creditors to receive the notice following the bulk transfer.

States where original UCC Article 6 is still in force may have enacted tax statutes that also require the transferee to give notice of a bulk transfer to the state tax authorities. Some of these statutes impose potentially large penalties for non-compliance on the transferee.

A bulk transfer notice must include all of the following:

* A bulk transfer is about to occur;

* The names and addresses of the transferor and transferee;

* Whether or not the transfer will result in the full payment of the transferor's debts, and if so the address to which creditors should submit their claims;

* The location and general description of the transferred property;

* The address where creditors can inspect the transferred assets and creditors list;

* Whether the transfer will pay existing debts and, if so, the amount of such debts and to whom owing;

* Whether the transfer is for new consideration and, if so, the amount of such consideration and the time and place of payment.

Original UCC Article 6 does not impose any duty on the transferee to distribute the proceeds of the transfer to the seller's creditors, unless otherwise required. If so, the transferee must assure that the purchase price is distributed to creditors identified on the creditors' list who timely filed a written demand for payment, after payment of secured claims. If the sales proceeds are not sufficient to fully pay the claims of the transferor's creditors, the transferee must distribute the proceeds pro rata to creditors. The transferee may avoid the burden of distributing the sales proceeds to creditors by commencing a proceeding that enables the transferee to deposit the proceeds into the registry of the appropriate court.

There is an issue under original UCC Article 6 of which state law governs a bulk transfer. If the transferee acquires inventory located in several states, must the transferee comply with the requirements of the bulk transfer statutes, if any, of each state where the transferor's inventory is located? Or does a given state's bulk transfer statute apply only where there is a transfer of more than half of the transferor's inventory located in that state? A transferee may have to comply with the bulk transfer statute in each state where the transferor's inventory is located.

When the transferee complies with all of the requirements of original UCC Article 6, the transferor's creditors have no rights against either the transferee or the transferred assets. The creditors' sole recourse is against the transferor. When the transferee fails to comply with all the requirements of original UCC Article 6, the transferor's creditors listed on the creditors' list or known by the transferee at the time of the transfer and/or the bankruptcy trustee appointed in the transferor's bankruptcy case can disregard the transfer and levy upon the transferred properties in accordance of local law.

Original UCC Article 6 does not indicate whether the transferee becomes personally liable to the transferor's creditors when the transferee fails to comply with all of the statute's requirements. The courts are divided--some impose liability on a noncomplying transferee while others refuse to do so. Those courts finding the transferee liable limit the amount payable to the transferor's creditors to the fair market value of the transferred goods.

Original UCC Article 6 also contains a very short statute of limitations for the transferor's creditors to pursue claims. As a general rule, they have six months from the date the transferee took possession of the goods to commence suit. If the transfer had been concealed, they have a longer statute of limitations, six months after they discovered the transfer. The courts are divided on whether a transferee's noncompliance with the statute is a concealment that would enable creditors to take advantage of the longer period.

Revised UCC Article 6

Four states--Arizona, California, Indiana and Virginia--and the District of Columbia have adopted Revised UCC Article 6. Revised UCC Article 6 defines a "bulk sale" as a sale that is not in the ordinary course of business of more than half of the value of the seller's inventory and under conditions in which the buyer is on notice that the seller will not continue to operate the same or a similar kind of business after the sale. A sale is in the ordinary course of the seller's business if the sale is consistent with either the usual or customary practices in the seller's kind of business or the seller's usual and customary practices. Revised UCC Article 6 applies to a bulk sale if the seller's principal business is the sale of inventory from stock (in California, the statute also covers restaurants) and the seller is located in the state.

Revised UCC Article 6 has significantly changed the notice requirement for bulk sales. The notice period has been extended from 10 to 45 days, which affords creditors more time to investigate the transaction. (California, however, requires only 12 business days notice of the transfer to creditors). If the transferor has 200 or more creditors (excluding certain categories of non-trade claims), the transferee may file a notice of the transfer in a public office instead of sending a notice to each individual creditor. This public filing requirement makes bulk sales less costly and complicated. However, it is also less likely that creditors of a large company will receive notice of a bulk sale. Creditors should check for additional notice requirements, such as California's requirement of publication of the bulk sale notice.

Revised UCC Article 6 also requires that the transferor and the transferee prepare a schedule of distribution, which contains an intended disposition of the proceeds of the bulk sale. The transferee must attach this schedule to the bulk sale notice. The schedule of distribution can indicate payment of the sales price to the transferor. If this occurs, so long as the schedule of distribution is included with the bulk transfer notice and the transferee then distributes the sale proceeds in accordance with the schedule (e.g., payment to the seller), the purchaser is in full compliance with the statute. The purchaser is then off the hook and is not responsible for the seller's failure to distribute the proceeds to its creditors. The creditors' sole recourse is against the seller. Creditors should check each state's version of Revised Article 6 for any variation of this provision. For example, California's version of Revised Article 6 requires the purchaser, or if the transaction is handled through an escrow, the escrow agent, to distribute all bulk sale proceeds to creditors where the price for the transferred assets exceeds $2 million.

Revised UCC Article 6 makes it easier for a purchaser to comply with the statute. The purchaser does not have to comply with the bulk sale law of every state in which the seller has inventory that is being conveyed. The transferee must comply with the law of one jurisdiction, the state where the seller's chief executive office is located. Revised Article 6 also excuses the purchaser from complying with the requirements of the statute where there is a transfer of assets with a value, net of liens, that is either less than $10,000 or exceeds $25 million (and in the case of California exceeding $5 million).

Revised UCC Article 6 has also substantially altered the remedies available to creditors injured by the purchaser's noncompliance with the statute. Creditors have a damage claim against the purchaser up to the amount of their claims rather than recourse against the transferred assets. The purchaser's cumulative liability to creditors is limited to twice the seller's equity in the inventory and equipment received by the purchaser, less the purchaser's payments to the seller and/or to its creditors. Revised UCC Article 6 creates one major exception to the purchaser's liability for noncompliance with the statute. A purchaser has no liability for noncompliance where it makes a good faith effort to comply with the statute or acts in the good faith belief that the statute does not apply to the bulk transfer.

In another change, Revised UCC Article 6 extends the statute of limitation for creditors to commence suit against the purchaser from six months to one year. If the purchaser conceals the transfer, injured creditors may commence suit within one year after they discover or should have discovered the transfer but in no event not more than two years after the transfer. The seller's and purchaser's noncompliance with the statute is not a concealment that would extend the statute of limitations.

While many states have repealed UCC Article 6, some states have retained original Article 6 and others have adopted Revised Article 6. Creditors in the latter states continue to have redress for noncompliance with original or Revised Article 6. They also have other state and bankruptcy law remedies that are likewise available to creditors in states that have repealed UCC Article 6.

Bruce S. Nathan is a partner in the law firm of Davidoff & Malito LLP in New York. He is a member of NACM and the American Bankruptcy Institute. He can be reached via e-mail at bsn@dmlegal.com
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Author:Nathan, Bruce S.
Publication:Business Credit
Article Type:Statistical Data Included
Geographic Code:1USA
Date:Jul 1, 2000
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