Protecting your business from your customer’s insolvency

In the second article in our series on risk and opportunity in the fashion retail sector, Rob Russell and Peter Manley assess one of the most prominent areas of risk for suppliers − the insolvency of a trade customer/ retailer.

We identify the principal areas of supplier risk and provide a guide to practical commercial and legal tools which should be applied by suppliers to protect goods placed in their trade customer’s possession in the event of the customer’s insolvency.

Retention of Title

In almost every trading relationship, retailers rely on agreed delayed payment terms with their suppliers in order to stock outlets and manage cash flow in the period between taking delivery of goods and effecting onward sale to a consumer. Often, the insolvency of a trade customer/ retailer will leave the supplier exposed without control of its goods and without payment. As an unsecured creditor, it will be in the unfortunate position of expecting to receive very little return.

Retention of title (RoT) to goods supplied is essential for a supplier to manage its exposure to the potential insolvency of its customer. When this approach is deployed effectively, a supplier can prohibit onward sale of its goods that are in the possession of an insolvent customer and can require delivery of the goods by an administrator or liquidator. In doing so, a supplier can significantly improve its position. 

RoT − The Principles

Under English law, title to goods passes at the time when the parties intend it to (s17, Sale of Goods Act 1979).

As a result, the parties to a sale agreement can agree that, notwithstanding that delivery of the goods has taken place, title has not passed to the buyer.

To retain title to goods following delivery, the following key principles apply:

  • Incorporation of terms – while a supplier’s terms of business may contain appropriate retention of title provisions, they will only take effect if those terms (and not the customer’s terms of business) are the terms on which the sale contract is concluded. Which party’s terms of business are incorporated in the sale contract is a matter of fact and will depend on the supplier having in place appropriate processes to ensure their own terms prevail over those of the purchasing customer. This legal process is often referred to as “the battle of the forms”.
  • “Simple” or “all monies” – retention of title clauses may be constructed to apply to goods supplied under a particular invoice only (title to which goods passes on payment of that invoice) (simple RoT) or to apply to all goods supplied to the customer until such time as all monies owing are discharged (all monies RoT).
  • Power of sale – in practice, in order to assert effective retention of title, the contract must effectively prohibit the onward sale of the goods following an insolvency of the customer. The construction of such contractual provisions has been the subject of judicial scrutiny in a number of cases and is often key to the supplier’s ability to control and obtain delivery of goods.
  • “Identifiable goods” – in practice, a supplier will be in a stronger position to enforce RoT rights if it is able to identify clearly the goods which have been supplied. Contractual provisions often provide that the supplier’s goods must be stored separately, but in practice this may not happen. Branding goods and placing appropriate markings on boxed goods to identify ownership is a useful practical step for a supplier to take.

Steps for a supplier to take to mitigate risk on customer insolvency

  • Review your standard terms of business. Do they contain appropriate RoT provisions, including automatic termination of the customer’s licence to sell on insolvency? Do your terms of business contain an effective “all monies” RoT clause?
  • Review your ordering process. In practice, are your terms of business (and not the customer’s terms of business) those on which the contract is formed (this is not always straightforward)?
  • Make your goods identifiable. Are there any steps that can be taken to make the particular goods more easily identifiable from the other goods in the customer’s possession? For example, are the goods or packaging distinctively branded?
  • Prepare a template letter which can be sent immediately to the customer when you become aware that the customer is in financial difficulties or has entered administration. Putting an administrator on notice as soon as possible that he is holding goods subject to RoT will significantly improve the prospect of their recovery quickly and without the cost of legal proceedings.
  • Develop processes to keep track of the location of goods which are in the customer’s possession. Knowledge of the location, inventory and warehousing arrangements for goods in the customer’s possession will assist in the recovery of your goods. If goods are warehoused at thirdparty premises, there is a risk that the third party will exercise a lien over the goods in its possession if it is owed money by the customer. 

In this situation, the supplier may have very little control over its goods, and suppliers should be alive to this risk.