Retention Of Title

It is normally the case that on the insolvency of a debtor, the estate has no money left with which to pay unsecured creditors once the secured and preferential creditors have been paid out. An effective protection for creditors who supply goods to a customer is therefore to contract on terms that provide that the supplier remains the owner of the goods supplied until they have been paid for. This type of contractual term allowing a supplier to remain the owner of goods pending payment, is referred to as a retention of title clause (ROT). So long as such a clause is valid, it will prevent the goods supplied from being swallowed up by a floating charge and will normally protect them from any other secured or preferential creditor's claim.

This essay will briefly consider the nature of ROT clauses and will seek to demonstrate how in bypassing the pari passu principle (that is, the principle that all creditors of the same class should rank equally in a winding up) they are by nature unfair, and that a system of registration as found in other jurisdictions may resolve the issue of fairness in determining priority on insolvency.

A simple ROT clause involves a provision in a contract of sale stipulating that property in the goods being sold will not pass from seller to buyer until the purchase price has been paid in full. Notably in England these types of clauses do not require registration as a security interest so as to be considered effective. In instances of more complex arrangements, sellers may seek to attempt to reserve title not only in the original goods, but also in the proceeds of sale of the goods (including products that have been manufactured from the original goods sold, as well as in the proceeds of sale derived from such products). There is however, a danger that a complex ROT clause may be found by the courts to have created a registrable charge, meaning it will be deemed void if it is not registered in accordance with Companies Act 1985 ss. 395, 396(1)(c).

The Romalpa case provides important insight into this area of law, because it was here that the Court of Appeal established that when a seller supplies goods to a buyer under a ROT clause, and authorises the buyer to sell the goods on the condition that the buyer accounts for the proceeds of sale, the seller may, on the buyer's insolvency, rely on the fiduciary relationship established between the two. Accordingly, the seller would have an equitable right to trace the proceeds and prevent them from being a part of the insolvent estate of the buyer. By using a ROT clause in this manner, the seller is given a right in rem in the proceeds and does not have to compete with the creditors for a share of the buyer's insolvency estate.

Difficulties have however arisen in instances where the initial goods (which are subject to the ROT clause) are subject to processing or mixing, making it difficult for the original seller to trace his or her goods. This is illustrated in the case of Borden (UK) Ltd v Scottish Timber Products Ltd where the court held that if a seller sells goods to a manufacturer with the knowledge that the said goods will be subject to the manufacturing process prior to their resale, there is no fiduciary relationship between the seller and the buyer. This means the seller is unable to rely on a simple ROT clause to ensure tracing. In other words, any rights the seller may have over the finished product will have to be provided for by way of express contractual stipulation. Post Borden case law imply that when attempts are made to draft ROT clauses with a view of retaining title in new products or proceeds thereof, the courts will construe these as intending to vest legal ownership of the manufactured product in the hands of the buyer subject only to a registrable charge in favour of the seller. It has however, been suggested by Goff and Oliver LJJ in the case of Clough Mill Ltd v Martin that it may be possible for a seller and buyer to agree which of them will become the owner of any manufactured product.

A most useful version of the ROT clause, from a creditor's point of view, is the all monies provision which allows the seller to retain title of the goods until all debts owed to him on any grounds have been fully paid. In an insolvency scenario, this means that in having the benefit of such a clause, it is not necessary to identify which items in a stock of supplied goods have been paid for as an all monies clause allows for all of the stock to remain as the seller's property.

An all monies clause is of particular importance when the value of the goods sold is rising. This can be illustrated in instances where paintings are supplied by the seller to a gallery under such all-monies arrangement, where the seller maintains ownership. The retained ownership will operate as security for the debt the purchaser owes in relation to the purchase price for the paintings but also for other debts (for example in relation to furnishings that have been supplied by the seller to the gallery under other contracts). In keeping an asset of escalating value out of an insolvency estate, the seller effectively advances in priority a series of formerly unsecured debts beyond the immediate transaction. This places that particular asset out of the reach of floating charge holders and ordinary unsecured creditors.

Does this mean that ROT clauses are unfair in offering a means of by passing the pari passu principle? Despite the recommendations made by the Company Law Review Steering Group (CLRSG), that a notice filing system be introduced for company charges (where complex ROT clauses would be registrable but not simple ROT clauses), ROT clauses do not have to be registered. This means that unsecured creditors can be unfairly misled concerning the insolvency risks they are running when they supply goods on credit to a company. Trade suppliers, for example, may see an array of assets in their debtor's possession, although these may already belong to other parties and there is no register they may resort to so as to reveal what assets belongs to whom. Arguably, it is not only the pari passu principle that is being bypassed in this instance, but so are the disclosure protections attending the use of security devices.

Furthermore, the situation is worse for unsecured creditors in light of the fact corporate accounts normally treat goods supplied under ROT agreements as purchases by the debtor company. Accordingly goods that are not the property of the company concerned commonly appear as assets in the balance sheet and it is rare for auditors' notes on accounts to comment on retentions of title.

The complaints made by consultees to the Cork Committee, was that claims involving ROTs were often confused and that without clarity the prospect of expensive litigation overshadowed commercial life. The response of the Cork Committee was to accept that such complexities could not be avoided and could be negotiated around. It may be said however, that all unnecessary legal uncertainties compound the informational unfairness that ROTs can occasion.

ROTs can also been deemed unfair, as they are not equally available to all creditors. Many suppliers use standardised contracts, making the costs of using ROTs relatively cheap, although the suppliers of some types of goods including fuels, paint, food and fodder, are unable to use ROTs as such materials disappear on consumption and leave the creditor with an unsecured claim. This effectively transfers insolvency risks unduly onto the shoulders of the type of suppliers who happen to deal in goods that are consumed in the short term. Similarly, this point may also be made in relation to suppliers who are repeat players, or who are engaged in a series of one-off transactions. Notably the latter may find it far more difficult to impose ROT clauses on their debtors.

ROT clauses may also be deemed unfair on the basis that they may be used to secure debts beyond the immediate transaction. This has been referred to previously in this essay as a particular problem involving assets of escalating value. The growth in value together with an all-monies clause (or all-liabilities) will not play a part in the insolvent estate and will therefore not become available to unsecured creditors. It will serve to prioritise some unsecured debts (those owed to the asset supplier) and will ultimately leave other unsecured creditors subject to a smaller estate than they had anticipated. Notably the floating charge holder would be the first to suffer in this instance.

This unfairness may be compounded by inequalities of bargaining power. Powerful creditors will be in a position to impose ROT clauses on debtors but those with less market power (or subject to more competitive circumstances) may not be in a position to retain title. ROT clauses are therefore unfair in so far as it shifts insolvency risks to those who are the newest and weakest players in the market.

On the other hand, there is an argument to state that ROT clauses are in fact fair. The Cork Committee did not see it right to outlaw ROT clauses in insolvency, noting that this would benefit floating charge holders, not unsecured creditors. The Committee stated, suppliers have opted for reservation of title clauses precisely because they seek to avoid the unfairness which results when they supply goods on credit, a floating charge crystallises and a receiver then takes the goods and realises them for the benefit of the debenture-holder leaving the supplier with nothing. It seems to us that suppliers are entitled, in such circumstances, to take steps to protect themselves and that it would be wrong to deny them the protection they seek.

It was the Committee's view that contractual freedoms should not be curtailed any more than it was absolutely necessary, although it was faced with its respondents' unanimous view that ROT clauses should at least be subjected to disclosure. So much so, that the Committee did recommend that a disclosure requirement in the lines of Article 9 of the US Uniform Commercial Code should be adapted to English needs wherein there would be disclosure of names of suppliers imposing ROTs, descriptions of the types or classes of goods covered by the ROT as well as the maximum amount that at any one time could be secured by a ROT.Notably consumer goods covered by the Sale of Goods Act 1979 (goods purchased for private consumption) would in this instance be exempt from such disclosure requirement. It is interesting to note that the Cork Committee did not take a view on how far tracing should be allowed to extend but, as noted, did consider that a duly registered ROT should be limited to the price outstanding on the goods immediately contracted for and should not take the all-monies or all-liabilities form.

If the recommendations made by the Cork Committee had been implemented, these would have dealt with some of the criticisms raised in relation to the unavailability of information concerning ROTs and the unfairness of extending ROTs beyond the immediate transaction. Despite the further criticism outlined by the Diamond and Crowther Committees no changes in this area of insolvency law have as yet been made. Notably both the Diamond and Crowther Committees advocated for a new register of security interests which would have included retentions of title to secure the payment of money. The Company Law Review Steering Group's 2000 Consultation Document does provide proposals for defining those ROT clauses that are deemed registrable, but as noted in the CLRSF's Final Report, it would treat complex, but not simple ROTs as registrable in its proposed notice-filling system.

Insolvency laws and processes should be designed to produce acceptable combinations of efficiency, expertise, fairness and accountability characteristics. This implies that the devices and processes that make up the regime for distribution should offer players in the marketplace a range of low-cost modes of protection against insolvency risks. These should however, avoid allocating risks in ways that produce unfairness or inefficiency and should satisfy principles of accountability and transparency. A way of helping deliver the above may include a system of registering ROT clauses and it is interesting to note that as in the USA, France and Italy also require that ROTs be registrable so as to be effective. Unfortunately so far there has not been an EC Directive to mirror this view. Furthermore, academics such as De Lacy further query whether in England any fundamental reform in this area will in fact take place given the rather dismissive tone of the Company Law Review's Registration of Company Charges Consultation Paper.

Bibliography

Finch, V, Corporate Insolvency Law, Perspectives and Principles, 2002, Cambridge University Press

Fletcher, I,F, The Law of Insolvency, Third Edition, 2002, London Sweet & Maxwell

Frieze, S, A, Personal Insolvency Law in Practice, 2004, Sweet & Maxwell

Keay, A and Walton, P, Insolvency Law, Corporate and Personal, 2003, Pearson Longman

Keay, A, McPherson's Law of Company Liquidation, 2001, Sweet & Maxwell

Tolmie, F, Corporate & Personal Insolvency Law, Second Edition, 2003, Cavendish Publishing

The Law Commission Consultation Paper No 164 - Registration of Security Interests: Company Charges and Property other than Land, June 2002, See Sale of Goods Act 1979 s.19(1) (the statutory basis for ROT clauses). If a seller attempts to reserve only equitable and not legal title to the goods, this will be treated as a charge void for non-registration. See case of Re Bond Worth Ltd [1979] 3 All ER 919.

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