Offering credit terms, is it risky for business?

Retention of Title – an effective remedy?
In our current difficult economic climate, businesses are taking an increasing risk when supplying goods on credit terms. Whilst, commercially, a seller of goods may have little option but to give credit if it wants to remain competitive, there is always the possibility that a buyer may become insolvent and be unable to pay. In this scenario, the seller may find itself in great difficulties. The presumption under English law is that title to goods passes when they are delivered, irrespective of whether they have been paid for. It is possible for parties to contract out of this presumption and it is against this background that retention of title clauses have developed in contracts.

The object of a retention of title clause (sometimes referred to as a Romalpa clause, after the first leading case on the subject, Aluminium Industrie Vaasen BV v Romalpa Aluminium Ltd [1976] 1 WLR 676) is to give the seller of goods priority over secured and unsecured creditors of the buyer if the buyer fails to pay for the goods because it is insolvent, or for some other reason which may be specified in the clause. The clause may be used in its basic form (supplemented by certain other standard clauses) or with one or more additional clauses, such as an all monies clause.

Basic form
The basic form of retention of title clause provides that title to the goods is retained by the seller until it has received full payment for the goods. It is important to ensure that such a clause reserves both legal and beneficial title: the reservation of equitable or beneficial title alone will not do. The basic clause should be supplemented by standard clauses containing:

  • A right for the seller to enter the buyer’s premises in order to repossess the goods (so that the seller will not commit a trespass when doing so).
  • An obligation on the part of the buyer to: store the seller’s goods separately from goods belonging to third parties; to mark them as the seller’s property; and to allow the seller access to the buyer’s premises to verify that this has been done.
  • This will enable the seller more easily to identify its own goods if a repossession of the goods becomes necessary.
  •  A list of insolvency related events which will trigger the seller’s right to demand payment for the goods (if not already due) and to repossess them, such as the service of a statutory demand, the issue of a winding up petition or some similar event.

In addition, although not a standard clause, if the goods supplied might be attached to the buyer’s premises (for example, in the case of heavy plant or machinery), it is worth including a provision prohibiting the buyer from annexing them to such premises without the seller’s consent. If goods do become annexed to the buyer’s premises, the consent of the owner of those premises will be necessary if the seller is to be entitled to repossess them in the event of non-payment by the buyer.
It should be kept in mind that a retention of title clause gives the purchaser the implicit right to deal with the goods supplied in accordance with the overall commercial relationship between the parties. That right does not automatically terminate upon the insolvency of the purchaser .This means that, even if the contract between a buyer and seller has a retention of title clause, if such a clause is incompatible with the overall commercial relationship, it may not be effective.

All monies clause
Under an all monies clause, the seller reserves ownership of the goods supplied until the buyer has paid not only for those particular goods, but also for any other goods supplied by the seller to the buyer, and has repaid all other moneys owed to the seller, regardless of how such indebtedness arose .
A limitation upon the practical effectiveness of the basic clause is that the seller retains title to goods only until those specific goods have been paid for. The buyer will, therefore, obtain title to those goods upon paying for them even if other goods received from the seller have not been paid for. The effect of the all monies clause is that all of the goods supplied, whether paid for or not, belong to the seller until the buyer has settled all invoices. In practice, the clause avoids the need to relate specific goods at the buyer’s warehouse with specific unpaid invoices.

Proceeds of sale clause
Where the goods supplied are to be sold on by the buyer, the object of a proceeds of sale clause is to enable the seller to assert rights in the proceeds of sale in order to satisfy the purchase price of the goods. Whilst this looks attractive at first glance, in practice, it is very difficult to enforce. Firstly, in a series of cases, it has been found that a clause of this nature amounts to a charge over the proceeds of sale of goods, meaning that it is void, or unenforceable, unless registered at Companies House against the Company. Secondly, in order to trace the funds from the sale of goods into the cash received for them, the seller must create a fiduciary relationship with the buyer and, in order to achieve that, the buyer must resell the goods as the seller’s agent. This would mean the buyer’s customers holding the seller directly liable for any defects in the goods, which is unlikely to be desirable from the seller’s point of view.

Mixed goods clause
Where the seller is selling goods for use in a manufacturing process (if, for example, it is a seller of components rather than finished products), and the goods supplied may be mixed or combined with other goods owned by the buyer or by third parties, the object of a mixed goods clause is to enable the seller to assert rights of ownership in any new product resulting from the manufacturing process. The case law distinguishes between:

  • Goods which maintain their identity (and which, if attached to other goods, can be separated without causing damage). Such goods will continue to belong to the seller where there is a basic form of retention of title clause as described above, so no additional provisions are necessary.
  •  Goods which lose their identity in the manufacturing process; for example, the sale of resin which is used in the manufacture of chipboard. The resulting new product (the chipboard) will belong to the buyer and the courts have held that if a retention of title clause purports to reserve rights in the new goods to the seller, the clause will create a charge which will be ineffective if not registered

It is clear from the case law, therefore, that the use of a mixed goods clause will achieve nothing for the seller. On the contrary, it may do harm if (following the same argument as described above in the case of a proceeds of sale clause), its invalidity also rendered the basic and all monies clauses invalid for non-registration as charges. Sellers of products which are quickly consumed within a manufacturing process should therefore consider alternative means of securing their purchase price, such as credit insurance.

Limitations on effectiveness
The following actual or potential limitations upon the effectiveness of retention of title clauses should be borne in mind:

  • If the buyer is a company in administration, no steps can be taken without the consent of the administrator or the permission of the court to repossess goods supplied pursuant to a retention of title clause . This prohibition also applies during any interim moratorium in an administration.
  • The retention of title clause must be properly incorporated in the contract between the seller and the buyer in order to be enforceable as a contract term. This is often where retention of title clauses fail. A signed set of terms and conditions, incorporating the retention clause will go a long way to establish incorporation of the term into the contract.
  • A retention of title clause may be ineffective if its operation is inconsistent with the overall trading relationship between the parties. For example, an all monies is unlikely to be effective in the context of an agreement to supply finished goods for immediate resale ).
  • Retention of title will be of little or no practical benefit where the goods supplied are perishable or have a low scrap value.
  • Retention of title is an area which generates a rapidly changing body of case law. Particular clauses are liable to be rendered ineffective by a court decision at any time, so a review of retention of title clauses is a particularly important aspect of the overall review of standard terms which sellers should be carrying out on a regular basis.

Conclusion and alternatives
Decisions of the courts have severely restricted the effectiveness of complex mixed goods and proceeds of sale clauses. The most that a well-drafted retention of title clause is likely to achieve for a seller is:

  • The right to enter the buyer’s premises without trespassing.
  • The ability to recover goods stored at the buyer’s premises which can be identified as the seller’s, possibly to the extent of all sums owed by the buyer to the seller.
  •  A possible action for damages for conversion against a receiver or liquidator personally who sells goods which were identifiably the seller’s.
  • A retention of title clause should be regarded as an adjunct to a proper credit control system, not as a substitute for it. Where the seller has doubts as to the financial standing of the buyer, the seller should consider:
  • Reducing the period of credit allowed to the buyer, or the amount of credit, or both.
  • Taking alternative forms of security, such as a bank guarantee or letter of credit.
  •  Obtaining credit insurance. This has become more readily available in recent years, with a greater choice of tailor-made products on offer. The existence of a satisfactory set of standard terms of business is likely to be a precondition to obtaining such insurance.