Australia: Navigating Through The Minefield Of Retention Of Title Clauses

In an economic downturn all parties to construction and supply contracts must adopt strategies to minimise exposure to the risk of insolvency of their contract counterparties. This involves considering contractual safeguards, adopting contract administration procedures designed to minimise exposure to risk and the early identification of risk minimisation measures for both principals and subcontractors.

Important for a supplier will be the use of a retention of title clause (also known as a Romalpa clause) within its supply contract. However using these clauses effectively can be difficult as the law surrounding their use has often been described as either a 'maze or a minefield'. Below is a snapshot of the critical issues to be considered and how to best address these when using the various types of retention of title clauses available.

What is a retention of title clause?

A retention of title clause is a clause in a contract for the sale of goods providing that ownership of the goods is retained by the seller until full payment is made. This is based on the concept of the separation of ownership of the goods and the actual possession of the goods.

The term 'Romalpa' clause is derived from the case in which retention of title clauses first received international attention, Aluminium Industry Vaasen BV v Romalpa Aluminium Ltd [1976] 1 WLR 676.

Retention of title clauses are an acceptable legal device for suppliers to ensure that, if the buyer becomes insolvent, the supplier will have priority for the goods over other secured and unsecured creditors.

Why are they used?

A retention of title clause stops ownership of the goods from passing with possession and will generally prevent goods becoming available for distribution among creditors when the buyer is in liquidation. It can also prevent the sale or use of goods by an administrator except in the ordinary course of business (as outlined later in this article in the section on the Corporations Act 2001 (Cth) (Corporations Act)). The meaning of 'ordinary course of business' was discussed by the Court in Osbourne Computer Corporations v Riddell (1995) 13 ACLC 1210. The Court held that goods supplied subject to a retention of title clause could be resold until such time as a demand for their return is made by the supplier. If a sale was made contrary to the terms of trade for the supply of the goods, the sale would not be in the ordinary course of business.

Where a buyer is insolvent and a valid retention of title claim exists, the liquidator must return the goods if in their possession or risk a damages claim for conversion by the unpaid supplier.

How does a supplier retake possession of the goods?

As the goods still belong to the supplier, they are entitled to take them back. A good retention of title clause would also give the supplier a right to enter the buyer's property and recover the goods if payment is not made.

Types of retention of title clauses

There are three common types:

• Title of Goods clauses.

• All Monies clauses.

• Tracing & Fiduciary or Trust Relationship clauses.

Title of Goods clauses

The most basic type of retention of title clauses state that ownership does not pass until the buyer pays the full purchase price of the goods. Title of Goods clauses allow the supplier access to collect the goods supplied under an unpaid invoice. However, they do not permit suppliers to collect goods supplied under invoices that have been paid, nor do they allow suppliers to collect money that may have been received by the buyer after the on-sale of the goods.

All Monies clauses

An All Monies retention of title clause has the same effect as a Title of Goods clause but also retains title in all goods supplied, even if some invoices have been paid (see Chattis Nominees Pty Ltd v Norman Ross Homeworks Pty Ltd (1992) 28 NSWLR 338). An All Monies clause may be desirable where there is a regular trading relationship between the parties and it is difficult to associate particular invoices with particular goods. However they can be difficult to enforce particularly where a buyer reduces his or her indebtedness to nil at any time. This means title to all goods supplied will pass to the buyer. If the supplier attempts to collect goods supplied in the future under an unpaid invoice, he or she will need to be able to identify those particular goods. The supplier cannot collect the goods supplied earlier.

Tracing & Fiduciary or Trust Relationship clauses

These clauses have the same effect as the previous two clauses but also contain a 'tracing clause'. This normally requires the buyer to keep the proceeds from the on-sale of the goods in a separate bank account on trust for the supplier. If the monies are not kept separately, a properly drafted clause will allow a supplier to trace the proceeds of on-sale of the goods into the bank account of the buyer.

What are the issues?

Numerous issues need to be considered when using any of the above. This includes:

• The retention of title clause must be communicated to and accepted by the buyer for it to be enforceable.

• The goods collected usually have to be the ones that were sold under invoices that remain unpaid.

• The supplier must be able to identify the actual goods supplied under the invoice containing the retention of title clause.

• The goods must be in a collectable condition, ie not incorporated into other goods etc.

Incorporating retention of title clauses into contracts

Retention of title clauses can be included in documents such as the terms and conditions of supply or trade, any credit application or supply or distribution agreement. They may also be printed on the invoices and statements issued after the supply of goods. The clauses are given statutory authorisation in sale of goods legislation applicable in the State or Territory in which the sale takes place.

However, regardless of where the retention of title clause is displayed, the supplier must be able to show the clause has been incorporated into the contract. This can be done by ensuring the retention of title clause is in the written contract for the sale of the goods, signed by both parties before the goods are supplied.

Where a retention of title clause is not written in the signed contract, the seller may be able to argue that is was incorporated into the contract by implication. This requires an examination of the general course of conduct between the parties, including the use of order forms and invoices to identify if a retention of title clause included on such documentation forms part of the contract.

Identifying goods

Under a simple Title of Goods clause, the supplier must be able to identify the goods supplied as those under an unpaid invoice. The supplier of goods has the onus to prove that the goods on hand are the goods in which title has not passed.

This can be difficult when the goods are mixed with other similar goods, unless the goods contain a unique barcode or other method of identification. Generally, title will be lost if the supplier cannot identify the goods.

Goods in collectable condition

The supplier's ownership of goods under a valid retention of title clause may be extinguished where:

• Goods are mixed or incorporated with other goods so as to lose their identity (as mentioned above). This will depend on the circumstances of each case and depend on the degree and extent of incorporation with other goods. The knowledge of the supplier at the time of supply is also important. If the supplier knew the goods were to be mixed with other goods, title will more likely have passed.

• Goods have been irretrievably fixed to the buyer's own or other suppliers' goods. The question then is can the goods be separated without destroying or seriously damaging the whole item.

• The goods are 'fixtures' and have become by law 'land' by being fixed to the land. This also applies to instances where a good is fixed to a building on the land, provided the degree of fixation is sufficient.

Sale of goods to a third party

Many retention of title clauses allow the buyer to on-sell the goods before payment has been made. Where a retention of title clause is silent on this issue, the courts will generally imply the buyer is entitled to on-sell the goods in the ordinary course of business.

The ability to on-sell goods can cause difficulty for the supplier of the goods where payment has not been made to the supplier. Section 27(2) of the Sale of Goods Act 1896 (Qld) and similar legislation in other States and Territories, provides that where a third party purchases goods from the buyer in good faith and without any notice of any lien or right to title of the supplier, the third party will gain a clear title to the goods.

Proceeds of sale

In such cases, a Tracing & Fiduciary or Trust Relationship retention of title clause would be of assistance to the seller. An example of such a clause is:

'Any proceeds of re-sale of the goods shall be held in trust for the supplier in a separate account until the supplier has been paid in full.'

To maintain the effectiveness of this type of retention of title clause, the seller should ensure the buyer does actually keep the proceeds of on-sale in a separate account. Otherwise, it is difficult to trace the proceeds of on-sale.

The ability of the seller to trace proceeds of on-sale can be further improved if the retention of title clause establishes a fiduciary relationship between the seller and the buyer. This relationship is more likely to be found when the contract and retention of title clause requires the buyer to keep the goods separate and keep the proceeds of on-sale of the goods in a separate account.

A recent example is the High Court of Australia's decision in Associated Alloys Pty Ltd v A.C.N. 001 452 106 Pty Ltd [2000] HCA 25. In this matter, a retention of title clause provided:

'In the event that [the buyer] uses the goods in some manufacturing or construction process of its own or some third party, then [the buyer] shall hold such part of the proceeds of such manufacturing or construction process as relates to the goods in trust for [the seller]. Such part shall be deemed to equal in dollar terms the amount owing by [the buyer] to [the seller] at the time of receipt of such proceeds'.

The High Court held that this retention of title clause was valid against the liquidator. The retention of title clause created a trust relationship between the parties whereby the proceeds from the manufactured goods are held on trust for the seller. In turn, the seller was entitled to trace the proceeds of the sale if the buyer has not paid and recover the proceeds of on-sale in priority over the rights of other creditors including secured creditors.

Amendments to the Corporations Act

Recent amendments to the Corporations Act, effected by the Corporations Amendment (Insolvency) Act 2007 (Cth), give the administrator of a company the right to dispose of property that is the subject of a retention of title clause.

Normally, an administrator is prohibited from selling goods except in the ordinary course of the business, with the written consent of the owner, or with the leave of the Court (see section 442C(2) of the Corporations Act).

With the changes to the Corporations Act, an administrator can dispose of goods, even after a demand has been made by the supplier for their return, provided the administrator acts reasonably (section 442CB(2)). Such disposal could still be considered in the ordinary course of the company's business (section 442C(8)).

Accordingly, when an administrator disposes of goods in a reasonable manner and in accordance with the exceptions in the Corporations Act, the supplier will lose its title to the goods even if the retention of title clause is enforceable.

Best practice in using retention of title clauses

Retention of title clauses are a useful mechanism to protect suppliers of goods against buyers who do not pay the full purchase price. When including these clauses in a contract, a supplier should:

• Ensure that the retention of title clause forms part of the contract.

• Determine the type of retention of title clause required ie whether it is required to protect the supply of goods under a single supply arrangement or under a standing periodic supply contract.

• Include a provision in the retention of title clause that the buyer keep the goods and proceeds of sale separate so that they remain identifiable and traceable where the goods are likely to be mixed with other goods and/or on-sold.

• Consider obtaining and registering a charge over the goods and the sale proceeds as security for payment where the goods are to be incorporated into an end product where the supplier does not retain legal ownership.

• Be aware of the recent amendments to the Corporations Act, which have seemingly eroded some of the advantages of a retention of title clause.

Phillips Fox has changed its name to DLA Phillips Fox because the firm entered into an exclusive alliance with DLA Piper, one of the largest legal services organisations in the world. We will retain our offices in every major commercial centre in Australia and New Zealand, with no operational change to your relationship with the firm. DLA Phillips Fox can now take your business one step further − by connecting you to a global network of legal experience, talent and knowledge.

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.