A Romalpa clause - Question and Answer PDF

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“A Romalpa clause is an effective weapon which protects an otherwise unsecured creditor.” Discuss and critically analyse this statement. Introduction Remedies for the unpaid seller For the majority of sales contracts, the issue of who has title to the goods generally arises only where the Buyer goes into liquidation or cannot pay his debts [1]. A bankrupt’s trustee must distribute his assets in a particular order, dealing first with his expenses, then the debts owed to preferential creditors (such as the Inland Revenue [2], the DSS, employees, and those with security), then with the debts of ordinary creditors, followed by any interest due [3]. Ordinary creditors therefore have fairly low priority. However, they provide a valuable service that is necessary for the business to thrive. They frequently supply goods on credit terms to buyers, which is not only beneficial for Sellers, because they will sell more goods, over a prolonged period and establish a more effective business relationship[4] but it is also important for the smooth running of the business which may buy on credit component materials necessary for the manufacture of their end-product; assisting them in maintaining a healthy cash flow[5]. Ordinary creditors are therefore essential to effective business practice but they get a ‘raw deal’ where their buyers go out of business, as their priority in terms of the available assets for distribution is low. English law provides a number of remedies for the Seller where the Buyer does not pay for goods; they may take action under Sections 49(1) or (2) SOGA1979[6] where the Buyer does not pay for the goods, and claim any interest due under the terms of the contract[7], once the payment is actually overdue[8]. They may also terminate the agreement, depending on its specific terms[9]. These remedies are, however, unlikely to be of any use against a bankrupt seller. They may alternatively have rights against the Buyer as an unpaid seller until the full amount has been paid[10]; they may have a lien on the goods so long as they remain in the possession of the Seller, or, where the Buyer is insolvent, they have a right to stop the goods whilst transit, and to resell them. The lien will be effective so long as the credit period afforded to the Buyer has expired, or where the Buyer becomes insolvent[11]. However, where the Seller permits the Buyer to take possession, the Seller will lose their lien[12]. In practical terms, the Buyer will usually have taken possession and often repackaged the goods for resale, or incorporated them into something else – this is core to the very purpose of allowing the Buyer credit terms.

Retention of title The answer to the Seller’s precarious situation as an unsecured creditor, was to allow the Seller to retain title to the goods until the Buyer had paid for them. In the Romalpa[13] case, the plaintiffs had supplied aluminium foil to Romalpa, under their standard terms which included a ROT clause. Subsequently, Romalpa went into receivership. The receiver held in possession a quantity of the aluminium foil, unprocessed, which was worth £50,000, as well as £35,152 representing the proceeds of subsales of foil. The Court awarded the Seller both the unprocessed foil and the money, on the basis of the doctrine of tracing, per Re Hallet’s Estate[14]. The use of retention of title (‘ROT’) clauses, or Romalpa clauses as they are sometimes called, was intended to reinforce the position of Sellers who were clearly getting a poor deal when weighed against the fact that the credit terms they provided were often the very lifeblood of the businesses they supplied to. These clauses (frequently likened to an extended version of the ‘right of lien’[15]) have mostly been used in business transactions (excluding services and consumables[16]) and their effect was to ensure that title was retained by the Seller, even though delivery was made to the Buyer, or their carrier, bailee or custodier for later delivery to the Buyer[17]. The clause specifies usually that the goods are still at the Seller’s risk until title, or ‘property’ in them, is passed to the Buyer[18]. The effect of a properly drafted ROT clause should be that title to the goods supplied to the Buyer does not pass until the occurrence of one of three events. The first, somewhat logically, is that the Buyer pays for the goods. The second is that the goods are resold by the Buyer, and property in them passes to a subbuyer. Finally, it may be that they lose their identity because they are incorporated into something else. Assuming none of these events occur, and the Buyer company is liquidated, the Seller retains title in the goods is entitled to enforce his right of ownership, reclaiming the goods and preventing the liquidator or trustee in bankruptcy from distributing them to the creditors in the aforementioned priority[19]. Where the Buyer is insolvent, the Seller needs to obtain permission from the administrator to repossess, or obtain leave of the Court. Because the Court may permit the administrator to sell any goods and materials that have been delivered to the Buyer (or to the Buyer’s site)[20], the administrator has a defence to a claim by the Seller if the administrator disposed of goods or materials that were subject to a valid ROT clause, having reasonable belief that they were entitled to do so[21]. We will consider later the methods that Sellers have adopted to deal with this problem.

Incorporation and registration Although ROT clauses appear to be an effective solution for the unsecured creditor to gain some ‘priority in the queue’, the use of such clauses has been historically problematic. Firstly, in order for such a clause to be effective, it must be incorporated into the contract. Thus, in Sauter Automation Ltd v Goodman[22], a quotation preceding the contract that included a ROT clause was held not to be incorporated. When the contractor purported to accept the quotation, this was made subject to terms contained in the main contract applying and thus the order was held to be a counter offer; as it denoted provisions relating to the transfer of ownership of materials that had been brought onto site for the contractor. The terms excluded the previous (conflicting) terms and conditions, and consequently, the ROT clause. Unfortunately, the case demonstrates how the validity of ROT clauses has often come down to a ‘battle of the forms’ exercise, where the Seller seeks to rely on a ROT clause contained in some document – often an invoice – produced after the contract was concluded[23]. Secondly, even when properly incorporated, the ROT clause has not always had the effect the Seller intended. Ordinarily where a Seller has an interest in goods, they are required to register that interest under the Companies Act 1985, under Section 365 (to be modified by the Companies Act 2006) – this requirement arises only where specifically a Company buying goods creates a charge[24]. This would not usually happen because as the Buyer does not obtain good title to the goods, and so it cannot create an effective charge over them in favour of the Seller: although there are exceptions to this considered later[25]. However, because the Seller’s interest is not registered, it is not easily discoverable by other debtors who may be considering making a loan to the Company[26]. So whilst there are advantages in the ease of creating the ROT clause, the fact that they may also easily be overlooked is a disadvantage to the Seller, and creates an unfair situation for other creditors who cannot make informed lending decisions. Problems with the operation of ROT clauses Our discussion so far has identified that some mechanism is required to assist unsecured creditors, who provide valuable credit to Buyers that is paramount to the success of their business operation. In this respect, Romalpa clauses provide an effective weapon of protection for the unsecured creditor. However, it has also identified various issues

with ROT/Romalpa clauses. These will now be looked at in more detail to see how far they have been dealt with. Goods may be sold to a sub buyer The very purpose of offering credit terms to the Buyer are so that the Buyer can sell on the goods to his own buyers and thus generate the income required to pay for them, as well as his profit, without tying up the Company’s resources. In practical terms, it could not be expected that the Buyer would not sell on finished goods to his own buyers before he paid the Seller for them. However, as mentioned, this is one of the events that would trigger title passing to the Buyer. This is essentially necessary since the Buyer needs to also pass title to his subbuyer, and if this could not be agreed, it is unlikely that the Buyer would find subbuyers who would agree that the original Seller was still allowed to repossess if the Buyer did not pay up! Further, as the subbuyer would likely not know about the ROT clause, they would obtain good title by the exception to the principle, ‘nemo dat quod non habet’, i.e. no-one can give what one does not have, for example under Section 25(1) SOGA1979[27] (discussed later). In order to deal with this, ROT clauses have been drafted, in the past, to authorise resale by the Buyer on special terms. The Seller will seek to secure an interest in proceeds from the sale of the goods to the subbuyer, as in Aluminium Industrie Vaassen BV[28]. This effect could be achieved where the ROT clause specified that the Buyer held the goods as an agent, a bailee and a fiduciary of the Seller, and selling for the account of the Seller. The protection established by Aluminium Industrie Vaassen was recognised formerly Insolvency Act 1986[29] although the clause does not apply where the sale is for both goods and services. Where the Buyer retained the proceeds of the sale in a specific, separate account, the Seller could, in the event of liquidation, claim the proceeds in satisfaction of the debt, in priority over other creditors. If however the proceeds had been mixed in with the funds of the Buyer, then the Seller may be able to ‘trace’ them using the equitable principles of tracing[30]. Whilst the process of retaining title to the proceeds rather than the goods themselves appears to deal with the problems of subbuyers, the Courts have not been willing to uphold such clauses consistently. In E Pfeiffer Weinkellerei-Weineinkauf GmbH[31], the contract between Seller and Buyer contained a clause authorising the Buyer to subsell, which required the Buyer to pass to the Seller all their rights under the subsale contracts, to the total value of the Buyer’s debt to them. The

Court decided that this had the effect of creating a charge on the book debts of the Buyer. Unfortunately, because such a charge would need to be registered under the Companies Act, and indeed was not registered, it was void[32]. The case can be distinguished from Romalpa for two reasons. Firstly, the clause setting out that the Buyer was subselling ‘for the account of the Seller’ was limited, to a total of the amount of debt owed to the Seller. Secondly, the clause did not state the Buyer to be a fiduciary of the Seller, in selling the goods. It may have been a reasonably obvious point but it was not expressly stated. Goods may lose their identity Where the contract uses a ROT clause but the Buyer incorporates the goods into something else, as we have identified, the clause ceases to have effect. As stated, this is a common problem because goods are bought on credit by manufacturers with a view to incorporating them into an ‘end product’ – for example, leather used to make shoes, elements used to make a radio or leather used to make handbags[33]. The Seller has not been permitted to retain title in the component parts once incorporated into something else, although where it is possible to separate the components again, without damaging them, per Hendy Lennox[34] the Seller’s title to those parts will still be good[35]. In Hendy Lennox Staughton J stated that the engines in question did not lose their identifiable quality even though they had been incorporated into other equipment. This succinctly states the required test, which is whether the component part has lost its identity during the manufacturing process: and where the process is irreversible, rendering the goods inseparable then, per Borden (UK) Ltd[36], the Seller loses title in the component part and cannot take title over the finished product. Any ROT clause cannot create such title over the end-product or the proceeds of its sale[37]. In such circumstances, the Seller would be able to retain interest in the end-product, but provided only that a charge was registered, which would need to be created by the Buyer. In fact, ROT clauses that have purported to retain an interest for the Seller in the finished product have in the past frequently been deemed a charge, and consequently held void because they were not registered, as required, under the Companies Act[38]. Re Bond Worth Ltd (1980)[39] is a further example of such a case. As can be seen, provisions of the contract that are not ROT clauses, on construction, can also result in the creation of a charge, which is granted by the Company buying the goods, that appears to be the effect intended by their inclusion[40]; and conversely, where the

parties intend a ROT clause to be incorporated, the Courts may decide to recharacterise the transaction. Where, for example, the parties choose to describe a clause as a ROT clause, the Court may instead hold that the transaction presents all the legal characteristics required for a floating charge[41].

Section 25 SOGA1979 The effect of Section 25 SOGA1979 is that, where the main contractor buys goods and, with the Seller’s (sub-contractor) consent, takes possession of those goods, they may pass good title to a ‘bona fide’ third party (i.e. the employer) where the goods are delivered under any ‘sale, pledge, or other disposition’, regardless of the fact that the contract for the supply of the goods between the main contractor and sub-contractor includes a ROT clause. This operates if the employer received “the same in good faith and without notice of any lien or other right of the original seller in respect of the goods”[42]. Essentially, this is the same scenario described earlier only in a construction context, where the Seller seeks to retain title even though the goods are sold to sub-buyers, but cannot where the subbuyer takes in good faith (i.e. without notice). The result of this issue is complex, as demonstrated by Archivent Sales and Developments Ltd[43]. In that case, the sub contractor Archivent supplied some ventilators to the main contractor, Robertsons. The contract contained a clause to the effect that title to the goods remained vested in Archivent, until Robertsons had paid fully for the ventilators. The employer, Strathclyde Regional Council, then paid for the ventilators, under the terms of a building contract. Robertsons went into liquidation and Archivent began proceedings to recover the ventilators. Strathclyde argued that they had title to the ventilators per Section 25(1) SOGA1979 but Archivent disagreed. Archivent’s argument was that the JCT contract between them stated unfixed materials that were delivered to site would not be removed unless the consent of the Architect was obtained, and as a result of this clause, the possession of the ventilators must have passed directly from Archivent to Strathclyde, without Robertsons ever having had possession. If Robertsons never had possession, they could not have made the requisite delivery essential for title to pass under Section 25(1) SOGA1979. Unfortunately, the Court rejected this argument, holding instead that delivery occurred when the ventilators came into Strathclyde’s ‘real control’, which was following their measurement on site by the Surveyor, in accordance with the terms of the building contract.

Per this decision (followed in W Hanson (Harrow) Ltd[44]), if an employer pays a main contractor for materials, then the unpaid subcontractor may not recover goods from a site as title will already have passed to the employer, regardless of the fact that title in the goods has not previously passed to the main contractor from the subcontractor (this does not apply in respect of contracts for works and materials[45]). In the event of an attempt to recover the goods, irrespective of whether to do so would cause damage, may result in charges for criminal damage (as to temporarily reduce the value or usefulness of goods is also damage for these purposes[46]).

Conclusion – a need for reform The concept of the Romalpa clause addresses a need to afford unsecured creditors with a better position. Without doubt this need does require attention. However, the law has limited the operation of ROT clauses to such an extent, that their application is unduly complex and unfair in effect. As noted, since Romalpa, an ROT clause will only be effect where the goods are identifiable[47], and remain identifiable if used in the manufacturing process[48]. Per Re Peachdart[49] the notion of tracing seen in Romalpa will generally not apply. However, a carefully worded clause in respect of subsale, provided the Buyer is stated to be an agent in a fiduciary relationship, may be effective[50]. Even where the ROT clause is successful, it can actually be disadvantageous to the Seller: for example, any entitlement the Seller has to bad debt relief for VAT purposes will be lost where the clause is upheld[51]. Further, the Seller will rarely be able to recover the damages suffered for a negative difference in sale price where he recovers goods from the Buyer under such a clause. Romalpa clauses are therefore no longer an effective weapon protecting an otherwise unsecured creditor. Their value has been diminished by the restrictions the law has placed on them. The limited circumstances where they are upheld, as has been demonstrated from the examples used herein, have presented “a maze if not a minefield”[52], producing “very difficult and uncertain”[53] results. It has been argued that Romalpa clauses are “…in reality just another security interest” and “it seems absurd to have an elaborate system of rules regarding registration of charges which can be avoided by this simple device”[54]. Conversely, however, it has also been argued that business is most effective when it is conducted transparently, and there is no good reason why such clauses should not be registered as charges. These would help suppliers to make more effective business decisions, and

would protect Sellers by giving them more priority than would be the case as an unsecured creditor. A system of registration may be compared to US law, under which, per the Uniform Commercial Code, Sellers are required to obtain a signed agreement from the Buyer that documents both the agreed arrangements and details of the goods secured. The Agreement is then perfected by being filed at public office[55]; and any documents that are not filed are not binding on third parties. Such a solution has not been met with universal agreement because it would affect a huge number of transactions. An alternative that has been suggested is a simple ROT provision that allows protection over the price of the goods alone, and this would not constitute a charge[56]. Yet another alternative proposed is a statutory duty to disclose the existence of any ROT clause if queried by a potential creditor, although this only deals with the issue of making effective lending decisions and does not address the problem of goods that have been incorporated into something else. It is clear that English law supports the view that parties should have freedom of contract. But as noted by Bradgate, parties exercising contractual freedom, in the interests of society and other stakeholders, should be obliged, in the interests of effective business practice, to disclose the details and workings of their transactions[57]. The existing law relating to ROT clauses does not meet these requirements to the detriment of both Seller and Buyer. A solution that deals with the issues identified – for example, perhaps by requiring disclosure of ROT clauses and permitting clauses to be upheld only...