Contract Review of Consignment Arrangements

In a previous series of posts I discussed some basic guidelines for establishing and administering contract review and approval procedures.  Whenever possible the general policies and procedures should include specific steps for particular types of contractual relationships that frequently arise during the course of business activities.  For example, a company engaged in sales activities may often have opportunities to enter into consignment arrangements with major customers pursuant to which products will be transferred to a customer’s warehouse prior to actual sale so that when the customer decides to make a purchase it simply removes the applicable products from the stockpile of consigned inventory and the actual purchase and sale is deemed to occur at that time.  A consignment arrangement will require a separate contract that lays out the terms and conditions upon which consigned products will be delivered and stored and the contract review process should include the following conditions:

  • The business case for the consignment arrangement should include information on projected volume and margins in order to allow the reviewing parties to determine whether the arrangement will meet company standards for opening a consignment account.  Consignment arrangements are costly to administer and can extend the period of time that passes before products are actually purchased and paid for; therefore, high margins should be demanded and provision should be made for covering shipping costs and other overhead expenses.
  • Vendor agreements relating to the products proposed to be included in the consignment arrangement should be reviewed and all necessary approvals and indications of support should be obtained from all such vendors.
  • The credit department should conduct a review of the creditworthiness of the customer to decide whether or not the customer qualified for participation in the consignment program.
  • An investigation should be made to ensure that the customer will be able to provide a suitable location for the consigned products and physically separate those products from other products, supplies and equipment.
  • The proposed form of consignment contract should be reviewed and approved by all departments impacted by the relationship such as credit/finance; legal; customer service (e.g., impact of consignment agreement on vendor warranty coverage); and product management (e.g., compliance with vendor agreement, inventory control etc.).
  • Before product is shipped under the terms of the consignment agreement the credit or legal department must take all actions necessary to perfect a security interest in the consigned inventory and must also obtain all documents to verify that the customer has obtained adequate insurance coverage for the products while they are part of the consigned inventory.
  • Plans should be made for regular inspections of the consigned inventory and review of the economic performance of the arrangement.

The content in this post has been adapted from material that will appear in Business Transactions Solutions (Summer 2008) and is presented with permission of Thomson/West.  Copyright 2008 Thomson/West.  For more information or to order call 1-800-762-5272.

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