Whenever goods are supplied on credit terms, there is always a risk that the buyer will not pay or is unable to pay. It is therefore very important for sellers to ensure they have done all they can to protect themselves.
This is particularly significant where a buyer goes into liquidation or a formal insolvency process, as there is an order for distribution of assets prescribed by statute and in most cases sellers in possession of unpaid invoices will fall into the ‘lowest’ category (that of an unsecured creditor).
Retention of Title
One of the most effective ways of doing this is using a retention of title clause (“ROT”). This is a clause in the contract for sale entitling the seller to:
- retain title for the goods sold until such time as he is paid,
- claim the proceeds of any resale of the goods; or even
- claim rights over any new products manufactured from the goods.
This is likely to be of greater value to the seller than a claim for the debt due under unpaid invoices.
A basic clause will provide that title to the goods is retained by the seller until he has received full payment for those particular goods. More popular is an “all monies clause” whereby the seller will reserve ownership of the goods supplied until all goods supplied by the seller are paid for and any outstanding sums due to the seller, irrespective of how such sums arose, are also settled. As credit amounts rarely register a nil balance, this can be very effective.
Using ROT clauses in practice
In principle, assets that are known to be subject to a valid ROT clause should not be sold by any insolvency practitioner in office without an order from the Court permitting sale free from such claims. In practice, it may be difficult to identify such assets (see further below) or there may not be enough time to obtain an order. Then the insolvency practitioner may decide to leave such assets out of any deal until the reservation of title claim has been dealt with; the purchaser can be offered the option to take the assets subject to any such claims and return them if any claims arise after completion.
Once a valid ROT clause has been incorporated into terms of sale, it is equally important for the seller to ensure that his terms of sale are effectively incorporated into the contract with the buyer and, in particular, that they are not superseded by the buyer's own terms (which are very unlikely to include a ROT clause).
In some cases it is possible to impose a simple retention of title clause after the contract is made (e.g. on the face of the invoice), as there is a statutory right for the seller to impose a condition on the passing of property under the Sale of Goods Act 1979. However, attempting to incorporate a clause by this method increases the scope for a third party (for example an insolvency practitioner seeking to maximise the assets of the insolvent buyer) to oppose the clause on the basis that it is a post-contractual document and thereby not effectively incorporated into the contract between the seller and insolvent buyer. It is therefore safer to incorporate a carefully worded ROT clause into the contract of sale (for example in the terms and conditions of sale). This is particularly important where a seller wishes to seek to enforce a more complicated provision, for example claiming rights over the proceeds of any resale of the goods or a product manufactured from the goods. Without a carefully worded clause, there is a much greater risk of successful opposition by a third party to any attempt to retain title.
Recovering the goods
In order to recover the goods, the ROT clause must provide the seller with a right to enter the buyer’s premises to repossess the goods. Failure to reserve this right will mean that the seller will commit a trespass if he attempts to attend the buyer’s premises to recover the goods. Further, if the goods become annexed to the buyer’s premises, consent of the owner of the premises (who may not be the buyer) is necessary in order to repossess the goods.
It is also highly unlikely that a third party will be bound by an ROT clause in the absence of proof of specific knowledge, tantamount to knowing that the goods in question were effectively not the buyer’s to sell.
Retaining the identity of the goods
A further key factor will be the extent to which goods retain their identity in the hands of the buyer (it is not possible for the seller to retain title in goods that he cannot identify). Therefore if the goods sold form part of a manufacturing process which alters the goods so that they do not retain their original identity (for example, where the goods are irreversibly mixed by the buyer with the goods of a third party), the goods will be irrecoverable where the retention of title clause only covers the goods in their original form. However, if the seller’s goods are attached to goods belonging to a third party and can be detached without damage to either goods, then they will not lose their identity and are recoverable.
It is difficult to predict with certainty whether an individual clause will be effective and each case will turn on its own facts, particularly the terms of the particular contract and the usage of the goods (if any). However, a seller's position is better protected where his terms of sale are effectively incorporated into his contract with the buyer and include a carefully worded ROT clause tailored to the issues that may arise in the specific market in which a seller operates. As can be seen, there are a number of ways a party can seek to oppose an ROT clause, so the devil will always be in the detail.
For further information on this or any other litigation issue, please contact Stuart Evans by emailing Stuart, by calling him on 08450 990045, or speak to your usual contact in the Commercial Disputes Team.
This document is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from taking any action as a result of the contents of this document.