Retention of title a practical guide for construction suppliers

Retention of title ("ROT") clauses have long been included as a standard provision in supply agreements in the construction industry since the landmark case of Aluminium Industrie Vaassen BV v Romalpa Aluminium Limited in 1976. Notwithstanding this, it is remarkable how many ROT clauses, even when correctly drafted, fail to operate effectively when they are most needed. This article is therefore intended to offer some practical guidance to companies that supply goods on credit terms to the construction market to ensure that they derive maximum benefit from their ROT clauses.

What is ROT?

By way of a brief summary, a ROT clause is commonly included in a supplier's standard contractual terms and conditions where it supplies goods to its customers on credit terms. This is intended to minimise the supplier's exposure for non-payment by retaining title (i.e. legal ownership) to the goods supplied until payment has been made in full. Given that the alternative approach of minimising risk for a supplier would be to demand cash on delivery, an option rarely open to suppliers in the construction industry, it is easy to see why a ROT clause is most commonly used.

The legal reason for the inclusion of such a clause can be traced to the Sale of Goods Act 1979 which allows contracting parties to agree the time at which title to the goods will pass. In the absence of an express provision, title to the goods will pass when the goods are delivered (it should be noted that this provision does not apply to work and materials contracts). By including a ROT clause, and thereby retaining ownership of the goods in question until payment is received, suppliers effectively grant themselves a right to recover the goods in the event of non-payment, irrespective of the solvency or otherwise of the purchasing company.

The insolvency of a customer

The benefit of retaining ownership over goods is most pronounced where a customer has entered into a form of insolvency process such as administration or liquidation, or into an analogous procedure such as administrative receivership. In these circumstances, because ownership of the goods remains with the supplier rather than the insolvent customer, they do not constitute an asset of the company for the purposes of distribution to creditors. The supplier will therefore be entitled to delivery up of the goods or reimbursement to the full value of the goods. Given the relatively high incidence of insolvent companies in the construction industry, it can be seen that the validity of a supplier's ROT clauses has a heightened significance and this position has been endorsed by the courts in the cases of John Snow v Woodcroft (1985) BCLC 54 and Armour v Thyssen Edelstahlwerke AG [1991 2AC 339].

In addition, if the goods are subsequently sold by an office-holder, such as an administrator or receiver, the supplier will be entitled to commence a personal claim against the office holder for interfering with its property. If however, the ROT clause is invalid for whatever reason, the supplier will be left with an unsecured claim against the company which can result in little or no repayment, depending on the extent of that customer's insolvency.

How to ensure that your ROT clause operates effectively

Supply contracts in the construction industry include ROT clauses as a matter of course. By following the steps set out below, however, the prospect of recovering goods supplied to an insolvent customer will signifi- cantly increase.

• Ensure that your retention of title clause is valid Firstly, and most fundamentally, the ROT clause should be incorporated in the supplier's terms and conditions which in turn should be prominently displayed on order forms, delivery notes, invoices and receipts. The clause must expressly retain the legal right to the goods, rather than merely retaining the beneficial title or directing that the sale proceeds be paid into a separate trust account. This is because the latter two examples will fail unless they have been registered as charges at Companies House (see, for example, Compaq Computers Ltd v Abercorn [1991] BCC 484). In contrast, it is not necessary to register a ROT clause which retains legal title to goods. In the majority of circumstances, the clause should also be drafted so that title is retained over goods until all monies due to the supplier are settled by the customer. This is commonly known as an "all monies clause" and offers a broader protection to a specific clause, particularly where there is an ongoing commercial relationship between supplier and customer. In practical terms, this will mean that provided there is an ongoing debt which has not been reduced to zero at any point, then the clause will capture all goods supplied to the customer (subject to the identification issues considered below). If however, the debt is reduced to zero (and title therefore passes to the customer), only goods which have been supplied subsequent to this can be recovered.
• Ensure that the clause has been incorporated in the agreement between supplier and customer As the ROT clause in question is commonly included in the supplier's standard terms and conditions, it is vital to ensure that it is validly incorporated in the contract which governs the commercial relationship between supplier and customer. There are a number of steps that can be taken at this stage to prevent difficulties arising in subsequently enforcing the clause:
  • The supplier should take whatever steps it can to bring the clause to the notice of the purchasing company before or at the time when the contract is made. Since a ROT clause is commonly printed on the back of invoices it can often be argued that this was insufficiently clear. The most effective means of overcoming this is to obtain written confirmation from the customer at the outset of the commercial relationship that the supplier's standard terms and conditions apply. A simple means of doing this could be to attach a confirmation form to a price list which should be signed and returned with any subsequent order form. In the absence of such a con- firmation, and if the position was not clear, it would be necessary to argue that there was a course of dealing between the parties which would mean that the ROT clause has been sufficiently drawn to the attention of the company and accordingly, had been incorporated into the contract.
  • Care should also be taken to ensure that the supplier's standard terms and conditions are those which govern the contractual relationship. This will obviously be overcome if written confirmation is received as suggested above. However, in the absence of such confirmation, it is common for disputes to arise because a purchaser will invariably respond to the supplier's order form by providing its own purchase order containing its own standard terms and conditions which is either silent as to title or states that title will pass on delivery. Indeed, a trap for the unwary supplier often comes in the form of a customer attaching a confirmation slip to its order form requiring the supplier to contract on the customer's standard terms and conditions. This process, effectively of offer and counter-offer, is known as "the battle of the forms". The general position in these circumstances is that the last person to send a form containing the standard terms and conditions prior to delivery will be entitled to rely on those conditions. This is why delivery notes commonly contain standard terms and conditions. However, the recent case of Lidl UK GmbH v Hertford Foods Ltd CA 2001, has created some uncertainty in this area by determining that in certain circumstances neither parties' standard terms would apply and the Sale of Goods Act would apply. As set out above, this will effectively mean that title will pass on delivery and the supplier will be unable to rely on its ROT clause again underlining the need for a supplier to ensure that it is confident of its contractual position.
  • Although a contract containing a satisfactory ROT clause is in place, a supplier should also ensure that it carefully monitors the subsequent commercial relationship with its customer so that the behaviour of both parties remains consistent with the operation of the ROT clause. This is important because, notwithstanding the documented relationship between the parties, a court would also look behind the superficial contractual position to ensure that the behaviour of the parties remained consistent with this.
• Take steps to ensure that your goods are readily identifiable Notwithstanding the existence of a validly incorporated ROT clause, a number of claims will still subsequently fail if the goods in question can no longer be identified. Given the very nature of the construction industry, this should be a real concern for suppliers. This typically takes two different forms:
  • In the first instance, goods will no longer be recoverable if they are sold to a purchaser that incorporates them in a larger product or works so that they are no longer identifiable in the form supplied. However, an additional complication often arises in construction, because goods supplied which are then fixed to real property (ie so that they would be classified as "fixtures" rather than "fittings") will lose their existence as chattels on incorporation and become converted into land (on the basis of the common law prin- ciple that anything attached to land becomes part of it - see the case of In Re Yorkshire Joinery Company Limited, 1967). For example, in building contracts, materials supplied pursuant to a contract incorporating a ROT clause, will often be incorporated into a building which itself merges with the land; title to the incorporated materials will then pass to the owner of the land by operation of law. In these circumstances, no action would lie against the landowner and the supplier would remain an unsecured creditor of the insolvent company. It is therefore vital to ensure that, where the supplier is contracting with the owner of the land, that a right of re-entry in the event of non-payment is included for the purpose of detaching these goods (see the case of In Re Samuel Allen & Sons Ltd [1907] 1 Ch 575). In this situation, if the goods supplied can be readily extracted from the land without causing damage to that product (and the supplier has a right of re-entry), then the goods supplied can be recovered and will revert to being chattels. In these circumstances, a supplier will have to consider the nature of its customer's business. In the construction industry, where goods are likely to be promptly incorporated into works (and are therefore unlikely to be recovered when incorporated), a shorter credit period in which payment can be made is likely to result in a larger recovery in the event of non-payment. In these circumstances, it would also be important to ensure that the customer did not have a contractual right to on-sell these goods until payment had been made in full, as if this occurs, the supplier would have no goods over which it could claim title. In addition, it would also be prudent to include a contractual provision that goods are boxed where possible and stored separately until they are used in the construction process so that they can be readily identified. Clearly it would be important to police such a provision by seeking, if practical, to periodically inspect those goods and a contractual provision could be included to cover this.
  • The second instance is more relevant to a supplier which relies on a specific (rather than all-monies) ROT clause. In this case, a supplier will have to prove that the goods held by its customer are those which relate to the unpaid invoices. It is therefore imperative in these circumstances that a supplier has been rigorous in ensuring that the products supplied can be identified, for example by reference to a bar code or serial number on the product, and that this can be cross referenced to outstanding invoices. However, as a matter of good practice, such an approach would also benefit a supplier with an all monies clause in promptly identifying and recovering its assets.

What should I do if a customer enters into receivership, liquidation or administration?

Following the entry of a customer into one of these insolvency processes, prompt steps should be taken to contact the relevant insolvency practitioners and put them on notice of the ROT claim. This is important because, as outlined above, if the goods are subsequently sold, a supplier would be entitled to commence proceedings for damages against the insolvency practitioner for interfering with goods. In practical terms, it may also be possible to come to a commercial settlement with the office-holder at this stage if the goods supplied can be used for the ongoing trading of the customer.

At this stage, it is common practice for the insolvency practitioner to provide a ROT questionnaire to establish full details of the claim. In addition to completing this document, it would also be prudent to seek an assurance that the stock has been secured and that a thorough stock take has been undertaken. It will then be necessary to attend at the premises to attempt to identify the stock. Naturally, this will be easier if the procedures set out above have been followed.

For further information please contact Ed Husband at [email protected] or on +44 (0)20 7367 3577.