What can a seller do in the drafting of a Sale of Goods contract to avoid or mitigate the issue when its goods remain unpaid?
In our previous article (Clauses in Commercial Contracts), we set out certain key elements to consider in drafting a contract for the sale of goods between commercial parties. In particular, we discussed the common terms in both tailor-made contracts and contracts containing standard terms and conditions, and highlighted the use of boilerplate clauses, which are standard clauses that are not usually individually negotiated in certain types of agreements.
Of the common boiler-plate clauses, retention of title clauses (ROT) (or a Romalpa clause – Aluminium Industrie Vaassen BV v Romalpa Aluminium  1 WLR 676) protect, among other things, one party from the insolvency of its counterpart. Such clauses particularly benefit suppliers of goods. In this article, we explain the importance of including ROT clauses in a contract, which we hope will enable parties negotiating such clauses to do so effectively and efficiently.
Section 19 of the Sale of Goods Act 1979 (SGA) gives the supplier of goods the ‘right of disposal of goods until certain conditions are fulfilled’. Based on this right, the seller can ensure he retains legal title to the goods under and ROT clause even though the buyer has taken possession of them. This way, the seller can protect his position if the buyer defaults on payment or later becomes insolvent. Once the buyer has paid for the goods, then the legal title of course passes to it.
If the parties do not include an express ROT clause in their contract, they will have to rely on the relevant provisions of the SGA, which may be less ideal. In particular:
- Although under section 17 of the SGA, title to goods passes from the seller to the buyer when both parties had intended it to pass, if the parties have not expressly agreed when title passes, that will have to beascertained by a detailed analysis of the facts and circumstances of the parties’ contract and conduct in each case.
- Moreover, where the parties have failed to make provision for the passing of ownership, there are default provisions in s 18, which specify circumstances where the property will in fact pass. The property must, however, be ascertained at the time in which the contract was created.
To avoid having to rely on sections 17 and 18 of the SGA, as mentioned, parties can expressly agree to a ROT clause. The idea behind retaining title to the goods until they are paid for, sold on, or used up is that, in the last resort, the seller can recover the goods supplied and prevent the buyer’s liquidator or trustee in bankruptcy disposing of the goods.
Application of ROT clauses
Sellers incorporating ROT clauses in their contracts need to be aware that under section 20 SGA, the risk of loss or damage remains the seller’s until legal title passes to the buyer. Therefore, by retaining title (e.g. as a form of security), the seller also retains the risk, meaning it will be liable and may even have to replace the goods if they are accidentally damaged or destroyed while in the buyer’s possession.
Second, the seller need to be aware that under s 49(1) SGA its remedy for unpaid good is only available where ownership in the goods has passed to the buyer. Thus by retaining title to the goods, the seller will not have such remedies available. Having said that, sellers can negotiate for the purchase price to be paid on a certain day, irrespective of delivery, which will instead guarantee the claim for remedy under s 49(2) SGA. If the buyer fails to make payment on the contractual payment date, the seller can seek to recover the goods, retaining title for as long as the goods remain unpaid for.
Different forms of ROT clauses
There are different types of ROT clauses.
(1) Reservation of legal title – which can be invoked to obtain the return of the goods if the price is not paid by the buyer. Such a clause is merely intended to prevent title passing to the buyers before they have paid the price, and not to assert continuing property rights in the goods. As such, this clause does not usually provide the seller the security which is commonly demanded by commercial lenders. Nevertheless, the purported security will still be valid as an agreement between the parties themselves.
(2) Reservation of equitable or beneficial title – which creates a charge in favour of the seller over the goods concerned. A charge is a right granted over an asset or assets to secure a debt, and which gives the charge holder priority to be paid ahead of any unsecured creditor in the event of the debtor’s (in this case the buyer’s) insolvency. To be enforceable, and give the seller standing as a secured creditor, the charge has to be registered as provided under the Companies Act 2006. Under s 859A of CA 2006, charges may be registered at Companies House within 21 days of creation. Although registration is not mandatory, if the charge is not registered, it will be void against a liquidator or an administrator, and also against other unsecured creditors (s 859H CA 2006).
(3) Claiming ownership of mixed and manufactured goods – minimise problems for the seller of goods that will be used as inputs in a manufacturing process. Where the goods have been incorporated into other products, the original goods are considered to have been subsumed into the newly manufactured products, which belong to the buyer and incorporate its profit. Yet under this clause, the unpaid seller is recognised as having an interest in the newly manufactured product that it can protect with an equitable charge that, as indicated above, should be registered.
(4) Entitling the seller to trace into the proceeds of any sub-sale by the buyer – which will create a charge (that should be registered) over the proceeds of the sub-sale. This clause is particularly relevant where a buyer buys goods from a seller and sells them on to a sub-buyer. The unpaid seller is unlikely to be able to get the goods back since title will have passed to sub-buyer, and hence will be seeking to recover the proceeds of sale instead. As indicated, this type of clause creates a charge over the proceeds of the sub-sale, and not over the goods themselves.
Additional clauses to consider in conjunction with an ROT clause
Together with the ROT clause, the parties may also wish to include one or more of the following clauses, as required:
(A) Rights of entry, seizure and sale – without which, if the seller is overdue payment, it may commit trespass if it goes onto the buyer’s premises to recover the unpaid for goods. This clause also ensures the seller will not be in breach of contract, or liable for conversion if it re-takes the goods and sells them. There should be a trigger to exercise the right built into the clause, which is commonly that the buyer is overdue in paying for the goods.
(B) All monies clause – by which the seller can retain ownership of the unpaid goods, until the buyer pays for them. This is helpful to sellers engaged in multiple sales to a buyer where the buyer may have paid for some but not all the deliveries.
(C) Detachable goods clause – which is recommended if the goods are of a type that may be attached to others. However, if the goods are attached to, or combined with, other goods such that the seller’s goods cannot be separated out, then the retention of title clause will no longer be enforceable, and the seller and the buyer will both hold joint title in the goods. If the goods can be separated, the title will remain with the seller. Additionally, where the seller’s goods are mixed with other goods of the same quality and nature, a clause like this provides for the seller asserting ownership over its relevant proportion of the mixed goods. Any such claim would form the basis for a charge in favour of the seller in relation to that proportion. As indicated above, such a charge ought to be registered.
(D) A ROT clause which obliges a buyer to store a seller’s goods separately. This helps the seller to identifying the goods it supplied so that it can retain title over them. If the buyer does not store the goods separately, the seller can seek damages for any loss incurred.
(E) Insurance – A ROT clause should also oblige the buyer to insure the goods against all risks from the date of delivery. It could further provide that if the buyer makes such a claim, the proceeds of the claim will be held on trust for the seller. This is helpful where the seller still has the title to the goods but they are damaged while in the buyer’s possession, since as noted above, under s20 SGA, the risk in that case is still the seller’s.
(F) Finally, a ROT clause may provide that the title in the goods passes when the buyer sells the goods to a sub buyer, giving the buyer reassurance that they can sell the goods with good title to their sub-buyers. However, such a clause effectively restates the position under s25 SGA, and so is not strictly necessary.
The above discussion focuses on the legal position particularly in respect of the seller, concerning its reliance on different ROT clauses in a sale of goods contract. We hope readers will find the explanations of the above issues and clauses helpful.
This is the second in our series of articles on negotiating and drafting contractual clauses, and we hope you will find the forthcoming articles of interest as well.
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