Securing Possessory Rights In Specially Manufactured And Assembled Goods

An entity (purchasing company) that has hired someone else (a vendor) to manufacture or assemble products on the purchasing company's behalf encounters significant risks that during the course of manufacturing the products, creditors of the vendor may foreclose on the vendor and take title to the products. The risks are encountered at three broad stages of the manufacturing process: (1) when the products are still in the form of unassembled parts or raw materials; (2) when the products are partially assembled in a work-in-process stage; and (3) when the products have been manufactured but not yet delivered. A purchasing company can take steps available under the Commercial Code to minimize these risks.

This article deals specifically with protections available to a purchasing company against foreclosure of its products while still in the manufacturing process. Except to the extent encompassed in the Commercial Code, liens or claims not arising under its provisions, such as certain governmental obligations, are beyond the scope of this analysis. Additionally, issues other than title and ownership of the products may arise between a purchasing company and its suppliers and manufacturers. Such issues, including product liability, tax, delivery, and shipping risks and insurance, are not covered in this article.

It should be noted that this article does not reflect changes made by Stats 1999, ch 991 (SB 45–Sher), which repeals Division 9 of the Commercial Code effective July 1, 2001, and replaces that division with revised Article 9 of the UCC, subject to some variations. Given that new Division 9 will not be effective until 2001, this article does not incorporate the adopted revisions.

The type of protection needed by a purchasing company depends largely on its contractual relationship with its vendor. The following three relationships are the most common (all of which assume that manufacturing or assembly of the products take place at the vendor's site):

• The purchasing company provides raw materials to the vendor (either from its own inventory or by contracting directly with the supplying company (supplier)), and the vendor provides labor for manufacturing or assembly.
• The purchasing company makes an up-front partial payment to the vendor to assist the vendor in procuring raw materials from the supplier. After the vendor procures the raw materials, it manufactures or assembles the products.
• The vendor has complete control over obtaining raw materials, and manufactures or assembles the products but is not reimbursed or otherwise paid until the products are complete.

When structuring contractual relationships, extra consideration must be given to the fact that changes often occur during the manufacturing process, which in turn may have a harmful effect on the purchasing company's right to the finished products if the vendor defaults on its obligations. Therefore, a purchasing company client must be strongly advised to inform legal counsel of any changes in its relationship with a vendor. Counsel may also consider drafting contracts that grant the purchasing company broad rights, and obligate vendors to monitor the purchasing company's goods diligently.

It is also important to remember that a purchasing company must not assume that it has priority title or a right to possession of the goods in any stage of the manufacturing process unless proper consideration has been exchanged with the vendor. With this background, we may begin to consider the issues affecting the purchasing company in each stage of the manufacturing process: Raw materials, work-in-process, and final product.

To eliminate the possibility that shipping delays will interfere with the manufacturing process, vendors usually do not begin the process until they have received all required raw materials. In many cases, materials may remain in storage with the vendor for a long period of time due to various factors, including requiring other materials, delays in the process, or actions from the purchasing company itself. Because raw materials are extremely fungible, they are most susceptible to use by the vendor for another project (which likely may cause delays and increase costs for the purchasing company), possessory actions by the vendor's creditors, or even unauthorized sales by cash-strapped vendors. For these reasons, the purchasing company must implement proper protections, which may begin at the time it executes a contract with the vendor.

Mere delivery of the purchasing company's raw materials to the vendor will not transfer title of the materials to the vendor. However, it is quite likely that the materials may be indistinguishable from the vendor's own inventory, especially if the vendor's creditors are not familiar with the raw materials themselves. The purchasing company may become embroiled in a dispute with the vendor or its creditors over the ownership of the materials. In such instances, the purchasing company is at a disadvantage, because it is generally not present on the site. Therefore, the contract between the purchasing company and the vendor must state clearly that (1) the purchasing company retains (and in no manner transfers or sells) title in the raw materials; (2) the materials are never to be deemed part of the vendor's inventory; and (3) the vendor is not authorized to sell any of the materials (except in satisfaction of its mechanics' lien after due notice has been given).

The contract also should contain a covenant by the vendor to keep the raw materials marked and segregated from its own inventory at all times while in its possession, including during the manufacturing process. In fact, it may be helpful if the purchasing company marks its materials before shipping them to the vendor.

Also, the purchasing company must ensure that its insurance continues to cover the raw materials while they are stored and altered at the vendor's facilities. Or, alternatively, the purchasing company may require that the vendor maintain adequate insurance to cover any loss or damage, and list the purchasing company as an additional insured. Finally, it is advisable (but not always possible) to obtain an acknowledgment of the purchasing company's ownership of the materials from possible competing claimants, such as lienholders in the vendor's inventory and landlords of the vendor's facility.

If the purchasing company directly contracts with a supplier to deliver the raw materials to the vendor, the purchasing company will hold title to the materials. The contractual provisions recommended in the previous paragraph apply equally here. In addition, the purchasing company may want to have its supplier mark the raw materials before shipment to the vendor.

If the contractual arrangement calls for the vendor to directly obtain the raw materials from the supplier and have the purchasing company pay the supplier directly, there is an increased risk that the materials may be mistaken for the vendor's inventory. If one of the vendor's creditors forecloses, that creditor may place a claim on all the materials (especially if the vendor secured the materials with its regular supplier or placed a small deposit on behalf of the purchasing company to enable purchase of the materials). To strengthen its protection in such a situation, it is recommended that the purchasing company negotiate its contractual arrangement so that it is treated as a buyer in the ordinary course (BOC). A BOC takes title free and clear of its seller's creditors. Com C §9307(1). A purchaser establishes BOC status by (Com C §§1201(9), 9307(1)):

• Acting in good faith and without knowledge that the sale is in violation of an existing security interest in the goods; and
• Purchasing from a person in the business of selling goods of the kind and not by a bulk sale.

In the aforementioned situation, in which the purchasing company pays the supplier directly for the materials obtained by the vendor, the purchasing company can obtain BOC status by: (1) arranging the transfer of title of the raw materials upon their identification for shipment to the vendor so that a sale is deemed to have occurred; and (2) in the event that the contract for raw materials is directly between the vendor and supplier, having itself be named as a party to the vendor-supplier contract (or, at the very least, issuing a check made payable jointly to the supplier and vendor) so that it is deemed to be a direct buyer. See Com C §9307; Security Pacific Nat'l Bank v Goodman (1972) 24 CA3d 131, 135, 100 CR 763. By being named as a direct party to the contract, the purchasing company is the direct beneficiary of all warranties issued by the supplier, and will not need to worry about their assignability.

If the purchasing company makes a partial up-front payment for the finished goods to the vendor (who then obtains the raw materials in its own name), the raw materials are still considered to be the property of the vendor, as part of its inventory. As such, creditors of the vendor who have all-encompassing liens on the same general type of raw materials would have rights superior to those of the purchasing company. To protect its right in the materials, the purchasing company may want to establish itself as the vendor's agent when purchasing the raw materials. Such an action is effective if it is clearly done in conjunction with all the other steps suggested in scenario 1 (i.e., being named a party to the vendor-supplier contract; explicitly stating the agency relationship in the contract; and issuing a check jointly payable to the supplier and vendor). This process may be cumbersome and may defeat the original purpose of having the vendor contract with the supplier. Further, if there is any defect in creating the agency relationship, the liens of the vendor's creditors will prevail unless the purchasing company can show that it was a BOC of the raw materials (which is very unlikely). Therefore, the best protection afforded to the purchasing company is to obtain a purchase money security interest (PMSI) in the raw materials, together with the requirement that the vendor mark and segregate the raw materials and work-in-process from its other ordinary inventory. A PMSI provides a superpriority in claims ahead of any perfected secured creditor of the vendor.

The technical requirements for a PMSI are that (Com C §§9312(3), 9402(1)):

• The purchasing company and vendor execute a written security agreement containing language that explicitly grants a security interest to the purchasing company.
• The purchasing company sends a written notice to holders of conflicting security interests in the inventory before filing a financing statement. This statement must describe the inventory and state that the purchasing company is taking a PMSI.

• The purchasing company files a UCC-1 financing statement. The financing statement may be filed before the security interest has actually been created, but it must be filed no later than ten days after the creation of the security interest.
• The purchasing company has given "value" for the raw materials.
• The value so given enables the vendor to acquire rights in or use of the raw materials.

The PMSI security agreement, notices, and UCC-1 filings must be drafted broadly so that they may provide protection for all raw materials obtained by the vendor through outside suppliers under contracts or purchase orders entered into concurrently with, or shortly after, execution of the contract.

The first four requirements, of course, apply to the creation of a UCC lien, and it is the fifth that provides for PMSI status. The fifth requirement of connecting "value" to the particular raw materials deserves further elaboration. The purchasing company must give value (in this case, the up-front payment) to the vendor in a manner that directly enables the vendor to purchase the raw materials. The value given must be directly traceable to those raw materials. Therefore, it is imperative that the purchasing company clearly document a direct connection between its up-front payment to the vendor and the materials purchased by the vendor. This is accomplished by issuing a check for the raw materials made payable jointly to the vendor and the supplier. In addition, the purchasing company's contract with the vendor must specify that the up-front payment is an advance payment to enable the vendor to purchase raw materials in which the purchasing company will have a PMSI. Provided that the purchasing company's payment to the vendor has been used directly for the purchase of raw materials, the purchasing company, by following the aforementioned method, will have established a PMSI in the raw materials up to the amount of the payments made.

The PMSI will cover delivered raw materials that were delivered by the supplier, but will not cover materials that have yet to be delivered under the relevant contract or purchase order. To obtain priority for rights in still-to-be-delivered materials (as well as being able to step into the vendor's shoes), the purchasing company must also take a lien against the contract executed between the vendor and its supplier. Such a lien cannot be a PMSI, and may be junior to preexisting liens in the vendor's general intangibles held by the vendor's creditors, unless the creditors agree to release or subordinate their liens. Com C §§9302, 9316. Valid releases and subordinations of liens also require a written agreement with the competing lienholders, and if for a release of a lien, the filing of a UCC-3 form.

If the vendor finances the purchase of raw materials by granting a PMSI to the supplier (e.g., if the purchasing company's up-front payment is an insufficient deposit for the supplier to release the goods to the vendor outright), a conflict between two purchase money secured parties (i.e., the supplier and the purchasing company) may arise. California law and the laws of many other states are not clear about which party takes priority. Therefore, to avoid such a situation, the purchasing company may want to place a restriction in the contract against the vendor financing its purchase of raw materials from suppliers through a PMSI transaction.

It is important to recognize that PMSIs and other liens do not grant title to the raw materials. If the purchasing company needs to obtain possession and title of the raw materials before completion of the manufacturing process (e.g., because of a vendor default), the purchasing company, as a lienholder, will have an interest only to the extent that it has made payments for the goods. The process for obtaining possession and title through strict foreclosure or public sale is discussed further in a separate section of this article.

Finally, if there are any important warranties with respect to raw materials acquired from an outside supplier that the purchasing company would like assigned to itself, the purchasing company may require (1) the vendor to confirm or assure that the warranties from the suppliers are fully assignable, (2) the vendor to assign the warranties fully to the purchasing company, (3) the vendor to cooperate with the purchasing company in prosecuting any warranty claims, and (4) the supplier to directly acknowledge and consent to the assignment of its warranties to the purchasing company.

If the vendor acquires the raw materials without receiving an up-front payment from the purchasing company, the purchasing company cannot (1) take title to those materials because a sale has not occurred (Com C §§1201(9), 2106, 2401), or (2) successfully create a PMSI because it has not "given value" that enabled the vendor to purchase the materials. This applies equally without regard to whether the vendor simply uses raw materials from its inventory or makes special purchases as a result of the purchasing company's order (in both cases, the purchasing company may have some protection if it obtains an assignment of warranties).

If the purchasing company wants to obtain a first priority position versus other creditors, but does not wish to advance much or any money, its best strategy would be to obtain a regular (non-PMSI) lien in raw materials and to ask the other senior creditors to subordinate their liens to the purchasing company's lien or release such materials altogether from their liens. However, the purchasing company should be advised that because nominal or nonexistent up-front payment creates a greater credit risk for the vendor's creditors, those creditors are unlikely to agree to a subordination or release on these terms.

As a general rule, a PMSI or other lien on raw materials will continue to be valid while the materials are in the work-in-process stage and being assembled into a final product. Com C §9107(b). It does not matter that the Commercial Code distinguishes raw materials that are "installed or affixed" to the final good from those that are "commingled or processed" into the final good. Once the purchasing company obtains a security interest in the raw materials, the security interest maintains its perfection and priority during the manufacturing process, without regard to how those raw materials are integrated into the final good.

However, to the extent that materials in the work-in-process stage incorporate raw materials other than those in which the purchasing company has a first priority lien, the liens of other creditors of the vendor in those raw materials will also continue to be valid during this period. This will result most likely in some form of ratable sharing between the purchasing company and such other creditors. In this situation, the purchasing company has essentially three options to ameliorate the problem:

(1) Require the vendor to use only raw materials in which the purchasing company has a first priority lien. This may not be practical in all manufacturing circumstances, and the vendor may mistake the source of the materials. However, this approach should be taken to the furthest extent possible.

(2) Have title to the material in the work-in-process stage pass to the purchasing company. Under the Commercial Code, title to goods passes in the manner specified in the agreement after identification of the goods to the contract. Com C §§2401(1), 2501(1). Identification is relatively simple to achieve under the Commercial Code. In fact, the vendor need not have performed all obligations under the contract for identification to occur. Comment 4 to Com C §2501. Despite the fact that the purchasing company's goods generally can be identified merely by their unique nature, materials in the work-in-process stage must be explicitly described in the contract and the purchasing company must require the vendor to mark and segregate the purchasing company's goods to eliminate any question of whether identification has occurred. Com C §2501(1). On satisfaction of the identification requirements, the contracting parties may determine the moment when title to the goods passes. See generally Com C §2401. The effectiveness of this approach depends on whether it is possible to identify materials in the work-in-process stage. Identifying them is inherently difficult, because the goods change in form throughout the manufacturing process. Because one cannot know for certain whether the vendor is in the business of selling materials in the work-in-progress stage, BOC status cannot be assured. As explained previously, without BOC status, holding title does not provide complete protection, and, therefore, it may be prudent for the purchasing company to require lien releases or subordinations from the vendor's senior creditors.

(3) Create a regular lien on the materials that are in the work-in-process stage. Such a lien probably cannot be a PMSI. Accordingly, the purchasing company may have to ask the senior creditors to release their competing liens and subordinate them to the purchasing company's security interest. The lien is valuable only to the extent that the purchasing company has advanced funds of some sort (whether or not traced to raw materials) or can establish damages in respect of the vendor's failure to deliver.

The purchasing company must carefully monitor the performance of the contracts with the vendor to ensure that if changes occur during the manufacturing process, prompt safeguards are provided. For example, if outside raw materials are used, a PMSI or other lien may be established to protect the purchasing company's interest in the final product.

As with the passage of title to the purchasing company for raw materials and materials in the work-in-process stage, parties may also use a contract to define when title to finished goods passes from the vendor to the purchasing company, provided that the goods have been identified by the contract. With the proper review (this may require the expertise of someone other than legal counsel), finished goods are relatively simple to identify. The purchasing company may wish to put itself in the position of a buyer in the ordinary course (BOC), because in this situation, the vendor is in the business of selling the finished good. In order for the purchasing company to claim that the contract has been completed, it must show that it has paid the vendor the full contract price.

If the purchasing company's goods are stored at the vendor's site, it is advisable to require that the vendor mark and segregate the purchasing company's finished goods to ensure that they are not commingled with and/or mistaken for the vendor's own inventory and equipment. Although beyond the scope of this article, vendors and purchasing companies must be made aware that the Commercial Code contains specific rules regarding risk of loss during shipment. Many of those rules may be modified by an express agreement of the parties. Com C §2509(4). Therefore, the parties must carefully evaluate and address risk of loss, particularly if the vendor will be responsible for or involved in delivery of the final product.

After the purchasing company has paid the contract price and title of the goods has passed to it, the remaining question is whether the sale of the finished goods can be voided or otherwise usurped if challenged by creditors as a hindrance on their rights to the vendor's inventory. Provided that the vendor has retained possession of sold or identified goods in "good faith and consistent with the current course of trade" for "a commercially reasonable time after sale or identification," that sale is not considered fraudulent or voidable. Com C §2402(2). Although a "commercially reasonable time" may be subject to objective standards, it is advisable to specify in the contract a reasonable period during which the purchasing company can store the goods without a fee and provide for a reasonable monthly storage fee thereafter. If the provisions of Com C §2402(2) are followed, the transfer of the finished goods to the purchasing company will be exempt from the general rule of CC §3440, which specifies that a transfer of personal property that is not accompanied by immediate delivery and actual change of possession is void as against the transferor's (in this case, the vendor's) creditors. CC §3440.9.

If the purchasing company does not obtain BOC status in its transaction with the supplier and a creditor of the supplier asserts an interest in the raw materials, the purchasing company may acquire unencumbered title to the goods under entrustment theories. By allowing the raw materials to remain in the supplier's inventory with the knowledge that the supplier was a merchant, the creditor will be deemed to have entrusted the supplier with the materials. Com C §§2403(2), 2403(3).

Notwithstanding the creation of a PMSI, other priority liens, or the purchasing company's BOC status, the purchasing company's title to and possession of the goods can be interrupted during any stage of the processes by mechanics' liens, government liens (e.g., if the goods are not manufactured pursuant to the Fair Labor Standards Act (29 USC §§201–219)), and liens under federal priority statutes. See Com C §9310. A discussion of the vast variety of liens is beyond the scope of this article. Accordingly, the purchasing company's contract with the vendor must require disclosure of all liens that are placed on any part of the goods being manufactured for the purchasing company's account. The contract must also contain a clause specifying that the vendor is transferring the final product free and clear from all liens and encumbrances of any kind.

With respect to mechanics' liens, CC §3051 permits a vendor who is in possession of and who is rendering a service on a good to retain possession of the good until its charges have been paid in full. If the vendor has not been paid within ten days after the payment due date, the vendor may begin the process of selling all or any part of the goods at auction. However, once the vendor has been paid the reasonable charges for the service performed, the vendor's lien is extinguished and the vendor must relinquish possession of the goods. Mechanics' liens, which cannot be waived by contract, have priority over title and other privately created liens. CC §3052. Because of the risk caused by mechanics' liens, the purchasing company should require the vendor to remove any such liens placed by its subcontractors immediately and at the vendor's own expense. Also, if the vendor is required to disclose all subcontractors engaged by it, the purchasing company will be able to easily identify the source of and responsibility for any mechanics' liens that are placed against its property.

The purchasing company has a right to replevin or possession with respect to any materials or goods it owns. Therefore, the purchasing company may file a writ of possession to obtain a court order for the release of the material or goods if the vendor refuses to release them. CCP §512.010.

On the occurrence of a vendor default and if the purchasing company's protections arise from a lien (PMSI or other), the purchasing company may foreclose on, and obtain possession of, the collateral. The methods by which foreclosure can be consummated are: (1) strict foreclosure, (2) private sale, (3) public sale, and (4) judicial action. The law, however, is not that practical in most instances.

In a foreclosure, the purchasing company must first obtain possession of the collateral. It may obtain possession by self-help as long as it does not breach the peace, and if there is no bankruptcy proceeding pending. Com C §9503. If a breach of the peace cannot be avoided, the purchasing company may pursue possession by filing a writ of replevin or similar writ or other judicial proceeding. If the vendor is in bankruptcy, the purchasing company must obtain special permission to lift the automatic stay to obtain the collateral. Once the purchasing company has obtained possession of the collateral, it may obtain title to the collateral by one of the following foreclosure methods: Strict foreclosure, private sale, or public sale.

Strict foreclosure under Com C §9505 is the most efficient method for a purchasing company to obtain title to the collateral if the vendor is not in bankruptcy. However, strict foreclosure extinguishes the purchasing company's right to pursue a deficiency judgment (see Com C §9505(2)) and the vendor and junior lienholders can (and, particularly, if the collateral is valuable, are likely to) object to force a sale. It is extremely difficult to avoid the deficiency judgment rule, because even if a vendor's agreement made after a default specifies that strict foreclosure is only for partial satisfaction of its debt, the agreement may not be enforceable even if commercially reasonable and made in good faith. See Com C §9505(1).

To foreclose, the purchasing company needs to send written notice to: (1) the vendor, (2) each other secured party who has sent written notice to the purchasing company of a claim to the collateral, (3) each judgment creditor of whose claim the purchasing company has knowledge, and (4) the Internal Revenue Service. Com C §9505(2); IRC §6050J(a)(1). See also Oliver v Bledsoe (1992) 5 CA4th 998, 1001, 7 CR2d 382.

If the vendor and the other parties receiving notice do not object to the strict foreclosure process in writing within 21 days, their claims to the collateral will be extinguished. Com C §9505(2).

If the debtor or a creditor objects to strict foreclosure, the purchasing company may have to pursue a private sale or a public sale of the collateral. Under these sale procedures, the purchasing company is free to pursue the vendor for any deficiencies.

Under a private sale, the foreclosing creditor cannot bid on the collateral unless the collateral is customarily sold in a recognized market or is the subject of widely distributed price quotations. Com C §9504(3). Because the purchasing company's interest is in obtaining the collateral itself, these requirements might make a private sale undesirable. However, if the purchasing company is nonetheless interested in a private sale, it is required to provide the vendor with written notice of the sale, unless, after the default has occurred, the vendor has signed a written waiver of the notice requirements.

Although a public sale is burdened by notice and other safeguard requirements, it may provide a more desirable result for the purchasing company, because it is permitted to bid for the collateral. Notices of a public sale must so state, describe the collateral and sale conditions, and be given far enough in advance so that the variety and number of bidders are broad. It is strongly advised that the notices be published in a newspaper of general circulation, and relevant trade journals as well. It is also advisable to permit inspection of the collateral before the auction. The auction itself must allow competitive bidding and be conducted by a licensed auctioneer to ensure its authenticity. There is no certain time period in which the auction must take place. The only provision that mentions a specific time period for a sale, Com C §9505(1) (which requires sales to be conducted within 90 days if the debtor has paid 60 percent of the price), seems inapplicable under the scenarios discussed here because the debtor (vendor) is performing a service and not paying money.

The purchasing company will need to consider whether the collateral ought to be sold as a unit or in parcels. This determination must be based on what is commercially reasonable to protect against future attacks on the sale. See generally Com C §§9504(3), 9507. Because of these uncertainties, it is advisable, if time permits while negotiating the contract with the vendor, to attempt to have a meeting of the minds regarding what constitutes commercially reasonable terms of sale.

Once the sale has been duly consummated, the purchasing company will obtain title to the collateral free from existing security interests. Defects in the foreclosure sale will not affect the purchasing company's title, unless it had actual knowledge of the defects, colluded with bidders or those conducting the public sale, or failed to act in good faith in a private sale. Com C §9504(4).

A narrowly applicable right exists for the purchasing company if the vendor becomes insolvent. If a vendor becomes insolvent within ten days after receipt of the purchasing company's first installment, the purchasing company (even if not a BOC) has a right to obtain title to those goods on its tender of the remaining contract balance despite the insolvency. Com C §2502(1). Note that shippers and carriers can assert similar liens. See CC §§3051a, 3051b, 3051.6.

Great care must be taken when engaging a vendor to manufacture or assemble goods, because there are a variety of risks associated with such relationships. It is highly advisable that companies obtaining the services of a manufacturer or assembler of products clearly outline the factual scenario and the parties' respective contractual rights and obligations. In this way, the steps taken for establishing priority liens can be carefully followed. Regardless of the context, all liens created by the purchasing company must contain detailed descriptions of the items that are subject to the lien. The descriptions must be drafted to cover raw materials, materials in the work-in-process stage, the final product, and any items used as replacements of the foregoing. This will make it perfectly clear that the purchasing company remains perfected in case any of the original goods are defective, destroyed, or stolen. See Holzman v L.H. Enters., Inc. (9th Cir 1973) 476 F2d 949. Wherever possible, the purchasing company may want to establish itself as a BOC so that it can take title free of the vendor's creditors. Also, with respect to finished goods, it is in the purchasing company's interest for the contract with the vendor to state a commercially reasonable period and price for storage.

SUMMARY OF RECOMMENDATIONS (IN ALL CASES, VENDOR PROVIDES LABOR)

Recommendations for Scenario 1

(1) The purchasing company may want to mark the materials before shipping them to the vendor.

(2) The purchasing company must clarify whether its insurance covers the materials while at the vendor's site, or whether insurance is to be negotiated in the purchasing company-vendor contract.

(3) The purchasing company-vendor contract must specify whether (a) the purchasing company retains title in the raw materials, (b) the materials must never be deemed part of the vendor's inventory, and (c) the vendor is not authorized to sell any of the materials. As an enhancement, the purchasing company can request an acknowledgement from the vendor's creditors that its materials are not included in the vendor's inventory.

(4) The purchasing company-vendor contract must state that title passes on completion of any work on the goods. To the extent possible, the stages of the manufacturing process must be listed.

(5) The purchasing company-vendor contract must require the vendor to disclose all subcontractors. It must also require the vendor to remove government and subcontractor liens (including mechanics' liens) at its own expense.

(6) The purchasing company-vendor contract must require the vendor to mark and segregate the purchasing company's materials from the vendor's inventory.

(7) The purchasing company may want to monitor the purchasing company-vendor contract throughout its term so that if changes are made during the manufacturing process, corresponding changes are made to the contract.

(1) The purchasing company must establish a PMSI in the materials received for its account (financing statement must also include any goods into which the raw materials are processed or incorporated, i.e., work-in-process and final product).

(2) As part of establishing the PMSI, the purchasing company's up-front payment must be made directly payable to the supplier (e.g., by issuing a check made jointly payable to vendor and supplier for the raw materials to be used). The supplier must be required to mark the materials before shipping them to the vendor.

(3) The purchasing company-vendor contract must contain a detailed description of the materials being obtained, the material in the work-in-process stage, and the final product. The contract must also require the vendor to mark and segregate same at all times during the manufacturing process.

(4) To the extent possible, the purchasing company-vendor contract must prohibit the vendor from financing its purchase of raw materials using a PMSI transaction.

(5) The purchasing company-vendor contract must state that title passes on completion of any work on the goods. To the extent possible, the stages of the manufacturing process must be listed in the purchasing company-vendor contract.

(6) The purchasing company-vendor contract must require the vendor to disclose suppliers, and subcontractors and require vendor to remove government, supplier, and subcontractor liens (including mechanics' liens) at its own expense.

(7) If the raw materials come with any important warranties that the purchasing company wants to retain, the purchasing company-vendor contract must contain (a) a representation from the vendor that the supplier's warranties are fully assignable and have been assigned, and (b) a covenant that the vendor will cooperate in the prosecution of warranty claims. The purchasing company must also attempt to obtain an acknowledgment and consent from the supplier of the assignment of its warranty to the purchasing company.

(8) To the extent possible, the purchasing company-vendor contract must define the terms and procedures of a commercially reasonable sale of the collateral on the occurrence of a default.

(1) Follow steps (3) through (8) in scenario 2.

(2) The purchasing company must obtain a regular lien against the raw materials and releases or subordinations of competing liens against the raw materials.

(1) The purchasing company must obtain a regular lien against the raw materials and releases or subordinations of competing liens against the raw materials.

(2) Follow steps (3) through (8) in scenario 2.

(1) The purchasing company-vendor contract must require vendor to mark and segregate materials.

(2) Since a PMSI cannot be created without a payment to the vendor, the vendor's creditors must be asked to subordinate their liens or release the purchasing company's materials from their collateral. The purchasing company must obtain a regular lien.

(3) The purchasing company-vendor contract must state that title passes on completion of any work on the goods. To the extent possible, the shared manufacturing process must be listed in the purchasing company-vendor contract.

(1) The purchasing company-vendor contract must require the vendor to mark and segregate the finished product.

(2) The purchasing company-vendor contract must state that title to the finished goods be transferred on completion of the last activity that results in the creation of the finished goods.

(3) Goods must not be stored at the vendor's site for longer than a "commercially reasonable time" or the sale may be voided. Because commercially reasonable time is an uncertain concept, the purchasing company-vendor contract must provide an agreed-on storage period and provide for the payment of a monthly storage fee after expiration of that period.