How far is it possible for a supplier of goods to protect himself against the insolvency of his purchaser by making use of a “retention of title” clause in the contract?
The supplier of goods or materials may provide in his contract with the buyer that he as seller should retain ownership of the goods until the buyer has paid for them even though the buyer has possession of them. In this way the supplier of goods can protect himself against the bankruptcy (or insolvency in the case of a company) of the buyer. The goods will not come within the control of any administrative receiver, administrator or liquidator; they are not the buyer’s goods.
Such clauses have been common on the Continent for some considerable time. In England they are of more recent vintage. They are made possible by section 19(1) of the Sale of Goods Act 1979, which permits in a contract for the sale of specific goods the reservation of the right of disposal of the goods by the buyer, so that the property in the goods does not pass to the buyer until, for example, he has paid for them in full. Such clauses are in common English commercial parlance called “Romalpa clauses”. They are so called after the Romalpa case: Aluminium Industrie Vaassen BV v Romalpa Aluminium Ltd [6] 2 All ER 552. In that case a Dutch company sold aluminium foil to an English company. The sale was subject to a reservation of title clause until full payment had been made, ie the buyers were allowed to mix the goods with other goods and sell them but only on condition that for as long as they remained indebted to the sellers they were to assign the proceeds to the sellers and claim against sub-buyers. The court held that the foil remained the sellers’ property and was sold by the buyers as their agent with accountability to them. The sellers therefore had the right to trace the proceeds of sale of the unmixed foil and recover them in priority to the secured and unsecured creditors.
Following this case the use of retention of title or Romalpa clauses has become commonplace.
Interpretation problems
Difficulties have arisen, however, regarding the interpretation of such clauses. A reservation of title clause will be effective only if full title to the goods is reserved. If, for example, the supplier of goods reserves only equitable and beneficial ownership, it will have the effect of allowing the legal title in the goods to pass to the purchaser. This will then create in the case of companies a charge which is registrable under the Companies Act.
The problem arose in the case of Re Bond Worth Ltd [0] Ch 228. Here the company sold fibre to a buyer who processed and spun the fibre into carpets. A clause in the contract provided that equitable and beneficial ownership of the fibre would remain with the supplier until full payment was made for the fibre. The judge, Slade J, held that the wording of the clause allowed property in the fibre to pass to the buyer, as the retention clause referred only to equitable ownership. The case is an object lesson on how not to create a valid reservation of title clause. The charge was void for non-registration under the Companies Act.
Tracing goods
In the most straightforward situations the Romalpa clause does not raise problems. However, on occasion it may be desired to trace the goods into a pool of mixed goods or indeed into a manufactured product. This could arise, for example, if there is a reservation of title in relation to bricks in tracing the bricks into a completed house or a garden wall! In such cases the law is most reluctant to allow a tracing remedy. It is not possible to trace into manufactured articles where the goods that have been supplied have lost their original character and are inextricably linked with a completed product. This was decided in Borden (UK) Ltd v Scottish Timber Products Ltd [9] 3 All ER 961. Here the Court of Appeal refused to allow the seller of resin to trace into chipboard into which it had been incorporated. A similar result was achieved in Re Peachdart Ltd [1983] 3 All ER 204, where leather was used in the manufacture of handbags: in the manufacturing process it was incorporated into the handbags and was no longer separately identifiable and so there could be no tracing.
In Hendy Lennox (Industrial Engines) Ltd v Grahame Puttick Ltd [4] 2 All ER 152 Staughton J held that in principle there was nothing to stop suppliers of engines from tracing the engines into generator sets into which they had been incorporated. As the judge said, the engines were not like the acrilan in the Bond Worth case, the resin in the Borden case or the leather in the Peachdart case, as they remained engines albeit they were connected to other things.
Fiduciary relationship
Wherever a Romalpa clause is created, a fiduciary relationship must exist between the supplier and the purchaser. This may be a bailor and bailee relationship or a principal and agent relationship. In essence this means a special relationship importing special duties must be created. In Romalpa this took the form of requiring the buyer to account to the supplier for the proceeds of sale and to store the goods separately. A properly drafted clause should therefore require these two things. Proceeds from the sale of manufactured articles to third parties should not be mixed with the buyer’s own money but stored separately and therefore be separately identifiable: see Re Peachdart and Hendy Lennox.
The supplier should not extend credit to the buyer. The ability given to the buyer to use the sale proceeds would be incompatible with the interest of the seller and would have the effect of neutralising any fiduciary relationship: see Re Andrabell Ltd (in liquidation) [4] 3 All ER 407.
In Clough Mill Ltd v Martin [4] 3 All ER 982 a receiver who had been appointed by a bank lender under a debenture was confronted with a claim by suppliers of the company to repossess yarn. The relevant reservation of title clause provided that the supplier was to retain the title in the goods until payment in full had been made or there was a sale to a bona fide purchaser. The clause also provided that in the event of the yarn being mixed, ownership of the products into which the yarn was incorporated would pass to the supplier. At first instance the High Court judge who tried the case thought that the effect of this second element of the Romalpa clause had the effect of invalidating the entire clause, as it would require registration as a charge. The Court of Appeal, however, reversed this decision and decided the reservation of title was effective over the unused yarn.
Present state of law
The effect of the state of the law at present is that the simplest type of retention of title clause is almost certain to be approved by the courts. It has the effect, in a receivership or liquidation, of allowing the supplier of goods — an ordinary trade supplier — to head the list of creditors (although in the eyes of the law, of course, he is not a creditor).
In cases where it is sought to trace into mixed goods or manufactured articles or to trace into the proceeds of sale, the effectiveness and validity of a retention title clause is more difficult, as tracing is likely to be difficult or impossible. This will be so in all but situations where the property remains distinct as in Hendy Lennox (Industrial Engines) Ltd v Graham Puttick Ltd (above). In other cases, where the goods are inextricably entwined with some other product, as in Borden (UK) Ltd v Scottish Timber Products Ltd (above), the clause will not be upheld.
The law on retention of title is still in a formative period and legislative intervention is a possibility. At the European level the European Commission is considering the law on the subject and a draft directive has been put forward.
One point should be noted, that in relation to administration orders where a “company doctor” is appointed, eg to help a company through financial difficulties. Once such an order has been granted, no steps may be taken to enforce any retention of title agreement except with the leave of the court and subject to any terms that the court may impose (s10, Insolvency Act 1986).
Romalpa clauses are of key importance in commercial practice and suppliers should ensure that they are properly drafted. Buyers and liquidators/receivers should beware: the former because of the fiduciary duties involved, the latter because suppliers will have to be treated distinctly and separately at the expense of creditors.
CORRECTION
Right of first refusal (“Mainly for Students” May 13, p 84)
Section 3(2) of the Landlord and Tenant Act 1987 has been amended by para 2(2) of Schedule 13 to the Housing Act 1988. This therefore affects the definition of who is, and who is not, to be excluded from being a “qualifying tenant” by reason only of having an interest which goes beyond a particular flat.
As amended, section 3(2) now reads:
A person is not to be regarded as being a qualifying tenant of any flat contained in any particular premises consisting of the whole or part of a building if by virtue of one or more tenancies … he is the tenant not only of the flat in question but also of at least two other flats contained in those premises.
A tenant therefore no longer loses his status as a qualifying tenant merely because an additional flat, or common parts of the building, are included within the same tenancy agreement. On the other hand, if the same tenant has accumulated two additional flats (in the same agreement or held under separate agreements) he will now lose his status as a “qualifying tenant” even if he does not have a majority of the flats in the same building. In these circumstances, the status of “qualifying tenant” will pass to the subtenants of that tenant (if any), as indicated in the article of May 13.
The writer is indebted to those readers who have drawn the 1988 amendment to his attention.
