Following on from our article on “Understanding and managing the risks of an insolvent acquisition” in the Q2 2014 edition of Global Insight, in this third article in our series of risks and opportunities in the fashion retail sector we 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 guidance about practical commercial and legal tools which suppliers should consider using to protect the goods placed in their trade customer’s possession, in the event of the customer’s insolvency.

We also look at the ways purchasers of assets out of insolvency can mitigate the possibility of acquiring assets to which ownership may subsequently be claimed by a third party supplier/manufacturer. 

RETENTION OF TITLE (“ROT”)

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 an onward sale to a consumer. The insolvency of a trade customer/retailer will often leave the supplier exposed without control of his goods and  without payment.

Retaining title to goods supplied is essential for a supplier to manage his exposure to the potential insolvency of its customer. If deployed effectively, a supplier can prohibit onward sale of its goods 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 his position where he may otherwise expect to receive very little return as an unsecured creditor.

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 - Whilst 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) 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 that 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 in this area and is often key to the supplier’s ability to control and obtain delivery up of goods.
  • “Identifiable goods” - In practice, it will assist a supplier in enforcing ROT rights if he is able to clearly identify 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 measure for a supplier to take.

The Pitfalls 

In Sandhu (t/a Ishar Fashions UK) v Jet Star Retail Limited (in administration) [2011] EWCA Civ 459), the Court of Appeal held that the contract between Sandhu (t/a Ishar Fashions UK) (the “Supplier”) and Jet Star Retail Limited (in administration) (the “Customer”) failed to automatically prohibit the Customer (acting by its administrators) from re-selling goods supplied to it by the Supplier upon the Customer entering administration. This is a prime example of how a supplier can be left exposed if the ROT provisions are not drafted to stand up to judicial scrutiny. 

The contract contained the following provisions:

  • An “All Monies” ROT clause;
  • Retained ownership by the Supplier of any goods supplied to the Customer until all goods supplied had been paid for in full; and
  • A right for the Supplier to require the Customer not to re-sell or part with the goods supplied by the Supplier which were in the Customer’s possession. 

The Customer entered administration and the administrators then sold the Customer’s business and assets (which included stock supplied by the Supplier that had not been paid for). The Supplier then brought a claim against the administrators for intentionally selling goods which the Supplier alleged that he owned under the contractual ROT provisions.

The court held that the administrators had not breached the ROT clause in such a way as to give rise to a liability because the contract, as drafted, provided the Customer only with an exercisable right to prohibit re-sale of its goods on the Customer’s insolvency. The contract failed to automatically revoke the right of re-sale on insolvency. 

This case highlights the risks for suppliers on customer insolvency where ROT provisions do not provide the protection that suppliers intend or require. Suppliers should test the ROT provisions adopted in their standard terms of business to ensure that they will operate to provide the protection which the supplier intends.

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

  1. Review your standard terms of business. Do they contain appropriate retention of title 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?
  2. 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?
  3. 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?
  4. Prepare a letter template which can be sent immediately to the customer when you become aware that the customer is in financial difficulties or has entered into administration. Putting an administrator on notice as soon as possible that he is holding goods subject to ROT will significantly improve the prospect of recovery of goods quickly and without the cost of legal proceedings.
  5. 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 third party 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.

PURCHASE OF DISTRESSED ASSETS - ARE THE GOODS THE VENDOR’S TO SELL?

In recent years the fashion retail sector has seen a number of high profile businesses and brands enter insolvency and/or undergo a substantial financial restructure. In certain cases this has led to the appointment of administrators over the company and a sale of the business and assets has followed swiftly. 

Business and assets sales in an administration process have, in many instances, provided opportunities for strategic acquisitions of established brand rights, stock and flagship retail premises.

Acquisitions of assets of a company in administration can represent good value for the acquirer who may obtain assets at significantly lower cost compared with a solvent corporate acquisition. Participants in the market who seek to complete acquisitions of distressed assets should be alive to ROT rights over goods in the insolvent entity’s possession. Even in circumstances where goods appear to form part of the assets being acquired, they can be subject to third party ROT interests. If so, the purchaser is typically at risk for those goods under the asset purchase agreement, which is also likely to impose significant obligations and indemnity liabilities on the purchaser should it transpire that the insolvent company did not have title to all goods sold.

Any purchaser of assets out of administration should not expect any form of warranty from the administrator as to title to the goods sold. The administrator will not have sufficient knowledge of the company’s pre-administration affairs to be prepared to give any warranty as to the goods which are purported to be sold. The purchaser is also likely to have obligations under the contract of sale that, in the event that a third party asserts valid retention of title over the goods purchased, the purchaser will deliver those goods up to the retention of title creditor and indemnify the administrators for any liabilities which the administrators incur by virtue of the sale of those goods.

It is therefore particularly important for the purchaser to undertake an appropriate level of due diligence of the goods it proposes to purchase to be satisfied that the goods will not be the subject of retention of title claims. Any such claims will affect the value of the assets and should therefore be reflected in the level of consideration paid.

Any purchase will occur in a very short time frame so being in the position to undertake a review of key supply contracts and to deal directly with third party suppliers and, where applicable, hauliers and warehousers, can put the purchaser in a strong position.

We have commented in this article on ROT in the two principal contexts of supplier protection on the insolvency of the trade customer and risk to an acquirer of assets out of insolvency. In the Q1 2015 issue of Global Insight, we will provide a retrospective look at insolvency and rescue in the Fashion Retail Industry in 2014 and likely trends and possible issues for the market in 2015.